With U.S. onshore drilling activity declining and exploration budgets slashed, the outlook for the contract drilling sector remains negative through the rest of this year, Standard & Poor's (S&P) analysts said Friday.

"We've assigned a negative outlook to about 30% of the contract drilling companies we rate, and we expect the negative bias for the sector to continue over the next 12-18 months as low oil prices continue to keep demand for drilling services depressed," wrote S&P’s Paul B. Harvey, a primary credit analyst.

The sharp reverse in crude oil prices has been keenly felt among the contract drillers, onshore and offshore. And it looks no better into 2016, with declining day and utilization rates expected to continue to constrain revenues and profitability.

"We expect the current downturn in the onshore drilling industry to diminish demand for older and less capable rigs, and that companies with greater amounts of these assets would be more vulnerable to negative rating actions," Harvey said. "We think the rig replacement cycle will continue at a modest level in 2015 as new rigs with advanced technology such as those used for horizontal drilling replace older-technology lower-specification rigs."

The exploration and production (E&P) industry's desire for new pad-capable rigs, i.e., rigs that efficiently drill multiple horizontal rigs from a single location, should lead to the "permanent retirement of a significant number of lower-specification rigs. As a result, average day rates and operating margins will likely improve across fleets, although this would be offset by the decline in the overall fleet size, resulting in diminished cash flows despite higher operating margins."

A "modest" recovery in land drilling should arrive in 2016, based on S&P's price assumptions for West Texas Intermediate crude oil of $60/bbl, and $70 in 2017.

"At those price levels, we expect returns on new wells will be sufficient to spur E&P companies to ramp up their drilling in unconventional oil plays as crude oil prices improve."

Improving natural gas prices also could support increased drilling levels, Harvey said, "although not to the extent of oil-focused drilling." S&P's assumption for gas prices is $3.25/MMBtu in 2016 and $3.50 in 2017.

S&P has negative outlooks for close to one-third (30%) of the contract drillers. Companies with a "higher quality fleet, good contract backlog and healthy balance sheet will be better able to weather the industry downturn."

Analysts with Tudor, Pickering, Holt & Co. said Friday the "big boy land drillers dominate" in clusters of the U.S. onshore. Five contractors they cover constitute more than half of the current total U.S. horizontal rig count. Helmerich & Payne Inc. has an estimated 18% market share, with Patterson-UTI Energy Corp. at 15%, Nabors Industries Ltd. at 11%, Precision Drilling Corp. at 7% and Independence Contract Drilling Inc., 1%.

TPH expects the first rigs to return to work will be the "best" rigs that have been idled, specifically those equipped with 1,500 hp, pad-capable, with alternating current (AC) drives. However, "existing customer relationships and footprint among key clusters will matter, in part, in determining which specific land drillers will gain (or lose) horizontal activity market share during next industry upcycle."

The "big four" U.S. land drillers -- Schlumberger Ltd., Halliburton Co., Baker Hughes Inc. and Weatherford International plc by themselves "have a collective ~275 idle AC rigs (versus our assumption of overall U.S. land rig count increasing by 500-plus rigs between now and year-end '16), so our working assumption is that the big boys are going to continue taking market share from smaller drillers as early innings of next industry upcycle unfold."