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It's a Wet, Oily World, Says Raymond James

The "perma-bulls" at Raymond James & Associates Inc. have dialed back their assumptions for the U.S. natural gas rig count and giving in to the inevitable: low prices are taking down rigs in the gas patch. The good news: there's "blistering" growth for oil and liquids drillers.

The domestic oil and gas rig count is forecast to end 2012 with a gain of about 30 rigs, which would represent a "very flat 2% growth," said analysts J. Marshall Adkins, Collin Gerry and Lenny Bianco.

"By year-end 2012, we think the dry gas rig count will fall from 315 rigs today to less than 190 rigs (a 40% decrease) followed by another 20%-plus decrease in 2013," said the trio. "For wet gas rigs, which currently total 490 rigs, we think activity will stay resilient but will bleed modestly lower in 2012. Specifically, we think the wet gas count will fall from 490 rigs active today down to about 470 active rigs by the end of 2012."

Meanwhile, around 180 new oil rigs are predicted to begin drilling by the end of 2012, which would be a gain of 15%. The loss of gas rigs and the gain of oil rigs would result in an estimated net gain of about 30 rigs by the end of the year.

Domestic producers have been paying attention. Chesapeake Energy Corp., the No. 2 gas driller in the country, last week cut its dry gas spending by 70% and sliced in half operated gas drilling activity (see Shale Daily, Jan. 24). ConocoPhillips is shutting in 100 MMcf/d of its U.S. output, while Consol Energy Inc. and Occidental Petroleum Corp., among others, also are reducing their gas drilling (see Shale Daily,Jan. 27; Jan. 26). Comstock Resources Inc. said Monday it was moving some of its domestic gas rigs to liquids plays.

"The rig count can be divided into three main buckets: oil, wet gas and dry gas," said Adkins and his team. "Obviously, the rigs most at risk in today's sub $3.00/Mcf gas world are the dry gas rigs (think areas such as Haynesville, Marcellus, Fayetteville). Two years ago, these emerging dry gas areas were a big deal, representing over 30% of all active rigs in the U.S. and responsible for an even greater percentage of the overall growth.

"Today, however, dry gas only represents 16% of the total U.S. rig count," or around 315 active rigs out of 2,000, based on Baker Hughes Inc. numbers. "This means that dry gas drilling activity is simply not a big of a part of the overall U.S. activity."

In the past two years the oil component of the domestic rig count "has seen blistering growth...On a year-end to year-end basis, we added 360 oil rigs in 2010 (75% growth) and 415 oil rigs in 2011 (55% growth). Interestingly enough, in 2011 half of the growth came from two plays in Texas, the Eagle Ford and the Permian Basin, which each added a little over 100 oil rigs each (and yes, we are still confused as to whether [Texas Gov.] Rick Perry or President Obama deserves the credit)."

There is a downside for producers in the move from gas to oil, however.

Returns on U.S. oil wells are "outstanding at today's oil prices," but lower gas prices would "clearly have a negative impact on the industry's cash flow available to drill more oil wells...The biggest takeaway to us is that the two-year trend of significant cash flow growth appears to be leveling off largely because of the fall in natural gas prices."

Last year natural gas still comprised roughly one-third of U.S. exploration and production (E&P) cash flow, noted the trio. "Thus, a 25%-plus decline in gas prices (moving from $4.00/Mcf in 2011 to below $3.00/Mcf) in 2012 will have a negative effect on overall industry cash flow."

The bigger driver obviously is going to be oil prices, analysts noted. If current strip oil prices are around $100/bbl West Texas Intermediate, "E&P cash flows should drift modestly higher in 2012, thereby allowing the oil-directed activity increase to more than offset a dry gas decrease." If oil prices this year fall closer to around $90, domestic E&P cash flows "could be down 10-15% in 2012 before picking back up in 2013."

The analysts acknowledged that only reviewing E&P cash flow is simplistic because E&Ps routinely outspend their cash flow. In addition the industry is "wily" in finding capital to fund oil and gas well returns by using royalty trusts and joint venture (JV) partnerships, for example.

"We expect the overall U.S. gas rig count to fall about 150 rigs (or 19%) from current levels," said the analysts. "From a bigger picture perspective, our gut tells us the gas count must and will fall more in 2012 but, when we look at it on a basin-by-basin level, JV programs, leasehold drilling and specific high-return areas seem likely to limit the magnitude of the gas rig decline in 2012."

Between December 2011 and December 2012, "we can conservatively add 200 oil rigs...A hefty portion of the incremental rigs will be committed to the Lone Star state (Eagle Ford and Permian). Likewise, the Bakken should remain a source of rig count growth, again at a more tepid pace. Finally, emerging oil plays such as the Cana Woodford, Granite Wash, Utica, and parts of the Rockies should contribute to grow oily activity."

Based on Raymond James calculations and Baker Hughes Inc. rig count numbers, the average U.S. rig count in 2008 averaged 1,897, with 1,491 rigs drilling for gas -- up 2% year/year -- and 379 drilling for oil, a 28% jump from the previous year. During the economic downturn of 2009 the rig count averaged 1,089 for the year, with 801 rigs drilling for gas (minus 46%) and 591 for oil (minus 27%).

By 2010 oil drillers started making a big move. Total rigs that year averaged 1,546, with 943 rigs drilling for gas, 18% higher year/year, and 591 rigs were drilling for oil, a whopping 113% higher. Last year saw another big jump in oil drilling, with the domestic oil rig count surpassing the gas rig numbers by 984 to 887, with oil drilling up 67% and gas drilling down 6%.

According to Raymond James, the U.S. oil rig count easily will surpass gas rigs through 2013. This year it is forecasting a 32% jump in the oil rig count from 2011 and an 18% decline in the gas rig count.

The 2012 average rig count is predicted to hit 2,031, 8% above 2011's average rig count of 1,879. Using current strip pricing for commodity prices layered, "we could see a reacceleration in operator cash flows as a result of accelerating production declines" in 2013, indicating 6% rig count growth over 2012, said the Raymond James team.

In 2013 the average oil rig count is expected to be 18% higher year/year to total around 1,526 rigs, while the gas rig again is expected to decline, down 13% from this year to average 634 rigs.

Beyond 2013, "the crystal ball gets murkier. We think that the trend in operator cash flows is a significant determinant of longer-term drilling activity. Given the huge production growth we're seeing, even if oil prices stay flat and gas prices stay weak, we expect modest growth in cash flows can continue to drive 5-8% rig count growth."

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