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Analysts: Rig Count Wetter, Still Too High

Unconventional natural gas and liquids plays account for a larger slice of the gas-directed rig count pie than they did just a short time ago. More horizontal drilling and the emergence of the second generation of shale plays characterize the market today, according to analysts at Barclays Capital.

"The trend toward drilling unconventional wells using horizontal rigs and hydraulic fracturing continues," the analysts said in a note published Tuesday. "From just 15% of the total rig count in 2006, a staggering 64% of rigs operating in 2010 were targeted horizontally.

"So far in 2011, horizontal drilling has made further gains, counting a 69% share of rigs. Gains in the share for horizontal drilling have mainly come at the expense of vertical drilling as directional drilling has stayed relatively constant."

The peak for the horizontal rig count was 666 in October when horizontal rigs had a 67% share of the aggregate count, according to Barclays. Now the share of horizontal rigs in the aggregate count is 69%, even though they number 638. "That horizontal rigs gained in share when the overall count was cut speaks to their importance in shale development and suggests that productivity gains are in store if the rig count does dip further," the analysts said.

Back in the summer of 2009 when Barclays first examined the rig count in the context of emerging shale activity, "shale was a relatively new word in the producer dictionary," the analysts said. All but the most mature shale plays -- the Barnett, Fayetteville and Woodford -- were seeing increased drilling. But since then activity has splintered, with liquids-rich plays getting more attention at the expense of dry gas plays.

"The Marcellus Shale has experienced strong growth since July 2009 and now counts close to 100 gas-directed rigs, on account of its liquids-rich areas and favorable economics," the analysts said. The Eagle Ford Shale has also witnessed explosive growth, thanks to the revenue uplift from its associated liquids production.

"Meanwhile, the Haynesville has languished since reaching a peak of nearly 180 gas-directed rigs about a year ago and now activity is roughly at 115 working rigs."

This trend is evident in the announcement this week that Range Resources Corp. had sold its Barnett Shale assets and would be building its acreage position in the Marcellus Shale (see Shale Daily, March 2).

Rigs have left dry plays for wet ones, in other words. While the newer wells have lower initial production rates, when one normalizes for the current shorter drilling times, results from the Haynesville do not exceed those of the liquids-rich targets in the Granite Wash, the Barclays team said. "We think that only a continued large migration of rigs to oil targets would meaningfully affect [natural gas] supply," they said.

The natural gas-directed rig count has fallen by about 100 rigs from last summer's peak, but further reductions are necessary if the market is to be rebalanced, argue the analysts. While independent producers appear to have stepped off the gas (in favor of oil), as a group they haven't stopped their pursuit of company-level production growth, Barclays said.

"Producers still care about volumetric growth but need not have it come from natural gas if it can be achieved from higher-value oil," the Barclays team said. "...[A] cut in gas-directed drilling activity need not cause a decrease in gas production. More likely, it would just decrease the rate of growth. We believe that the current level of drilling is adding production to the market."

In order to rebalance inventories by the end of October, the rig count "must be cut sharply," the analysts said. The preference for oil targets has been "a major driver" in lowering the gas-directed rig count. "However, we see limited downside to current drilling levels because of high producer hedging levels, drilling for gas with associated liquids, JVs [joint ventures] and held-by-production leases."

Last August Baker Hughes charted the rig count's peak at 992 while Smith S.T.A.T.S noted the peak at 1,002 in September, according to Barclays. Since then the count has fallen more quickly than the analysts had anticipated to just above 900. "However, after a more-or-less steady drop through the fall and into the beginning of the year, the overall count has stabilized and even gained a few rigs of late," they noted.

Noting that producers charted sequential production growth in 10 of the 12 months of 2010 with an average rig count of 940, the analysts said activity needs to moderate further to a level that puts supply on a declining trend.

"We put this number at approximately 800-850 rigs, though the risk is that even this count could grow supply," they said, "especially as producers work off a backlog of drilled but uncompleted wells in 2011.

"...[W]e calculate that a rig count of 725 from March-October would result in end-of-March inventories of 3.5 Tcf."

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