The 54th Reed-Hycalog Rig Census on the U.S. land drilling market indicates that for the first time in years natural gas supply is beginning to outweigh demand, Raymond James & Associates said last week.

"Because of this, utilization levels have begun to head south and bring dayrates down, as well," said Raymond James' J. Marshall Adkins, Collin Gerry and James M. Rollyson in a note. "Given a flat market, Reed-Hycalog expects utilization levels to fall to 78%, but our forecast for a decline in drilling activity next year could leave utilization even worse."

The census "obviously has a negative effect on the U.S. land service companies for next year, and explains why we remain, on average, 24% below the Street for 2008 EPS [earnings per share] for North American-weighted service names."

Analysts said that longer term, "all is not lost. The number of newbuilds is tailing off significantly, and as the market softens, more rigs will be laid down due to attrition...Additionally, any slowdown in activity will likely be short-lived, as increasing domestic decline rates justify higher drilling activity levels just to maintain production levels. In other words, the treadmill continues to accelerate."

The Raymond James trio noted that it was "important to keep things in perspective. A slowdown of 4% in the rig count is rather modest when compared to the 10%-plus corrections we have seen in recent history."

The census report, said the analysts, is one of the "most useful pieces of long-term data for those who follow the U.S. land drilling business." The census provides data going back 52 years except for 2002, when Schlumberger decided to discontinue it. The census is now published by Grant Prideco.

The analysts' review of the census found that "while demand for rigs continued to increase this year, the market was not able to absorb the prolific rate of capacity additions. As such, industrywide fleet utilization took a sharp downtick this year, the first since 2003. This data supports our underlying thesis that as we head into what we believe will be a less active 2008 in terms of drilling activity (down 4%), dayrates and utilization levels may continue to suffer for U.S. land rigs. However, we do believe that capacity additions going forward will subside meaningfully from 2007 levels and attrition rates on older, less-capable rigs will continue to help stabilize the market over the long term."

If the analysts are right in their 2008 natural gas price forecast -- $7/Mcf -- and activity assumptions (down 4%) -- "utilization levels have the potential to come in even lower. This could translate into further headwinds for rig contractors in terms of dayrates. The gap between supply and demand has already begun to chip away at the rig rates, which have declined throughout 2007. In the 2007 Reed-Hycalog survey, contractors realized the potential dangers and listed rig rates as their single most important issue."

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