Weaker-than-expected North American natural gas drilling in the last four months has taken a bite out of earnings for at least two major U.S. oilfield contractors, and the slowdown is expected to impact energy earnings across the board for the next few months, according to energy analysts.

Nabors Industries Ltd., the largest U.S. land driller, on Thursday said it will miss its $1/share 1Q2007 forecast because of reduced rig activity in the United States and Canada and a weaker demand for well servicing. It now expects earnings of 80-85 cents/share for the period.

"The impact of the shortfall in operating rigs is largest in our U.S. Lower 48 land drilling operations followed closely by our Canadian and U.S. land well-servicing units," said CEO Gene Isenberg. "Obviously, North American gas related drilling activity has been much weaker than we previously anticipated as we now have approximately 60 idle rigs in our U.S. Lower 48 land drilling operation, representing an increase of 36 rigs since the beginning of the quarter."

Nabors' announcement followed a similar profit warning by Halliburton Co. in mid-March. Halliburton now generates 61% of its business from North American operations, but it is shifting its operations overseas as the markets change (see Daily GPI, March 13). Halliburton lowered its 1Q2007 earnings guidance, blaming a "significant portion" of the loss to lower results on decreased drilling and completion work in Canada and the United States. Halliburton now expects to earn 49-54 cents/share in 1Q2007, below Wall Street's estimate of 59 cents.

The recent decline in North American gas drilling is not a complete surprise. The first signs came late last year in western Canada, as higher service costs led several producers, including Devon Energy Corp. and EnCana Corp., to cut back on their conventional gas projects (see Daily GPI, Nov. 2, 2006; Oct. 26, 2006). In February, Nabors' Isenberg said only the company's Alaska operations performed well in the final three months of 2006. Canadian operations were "dismal," and going forward, he expects a "smaller downturn" in U.S. rig markets (see Daily GPI, Feb. 8). Also last month, the Canadian Association of Oilwell Drilling Contractors reported a slowdown in the Canadian oil patch following an early spring thaw (see Daily GPI, March 20).

"The 'North American softness' story is not over," wrote Merrill Lynch energy analyst Alan Laws. "Expect more negative news flow, more rigs to be let go, more pricing pressure" and more earnings per share cuts.

Citigroup energy analyst Geoff Kieburtz reviewed a stack of drilling data from several reliable sources, including Baker Hughes and some of the top drilling operators, including Halliburton, Nabors and Patterson-UTI. He concluded in a report issued Friday the "signs of a recent decline in drilling activity are abundant," and "permitting trends also indicate the active rig count likely declined," beginning around September 2006.

Using regional and state breakdowns, and in some cases, examining individual state districts, Kieburtz noted the "most significant declines have taken place in the Rockies and the Midcontinent regions." Although "definitions vary between sources, and individual data points have to be viewed in the context of the overall trends...we are persuaded that a slowdown has occurred..." and "overall North American profitability is likely to be disappointing this quarter."

No clear point of variance between the major rig counts was easily identifiable, Kieburtz wrote.

"In certain cases such as Wyoming, evidence of a decline in the rig count was consistent across the group, with the rig count indicated down between 10% and 30%. We would note this consistency is highly supportive of Halliburton's comment on a decline in Rockies drilling activity. Moreover, all rig count providers indicate they do not count CBM [coalbed methane] drilling activity, further underscoring the company's comment. In addition, Nabors' healthy Rockies exposure lends additional credence."

The rig data indicates an overall week 1Q2007 for U.S. companies, Kieburtz wrote.

"The significant decline in drilling activity over the past four months should portend a meaningful decline in the number of new natural gas wells drilled in the first two to three months of 2007," the analyst said. "We believe this likely reduction in the number of new wells drilled will lead to modest reductions in overall natural gas production in early 2007."

The effect on total 2007 gas production is difficult to determine. "Nonetheless, the difficulty in offsetting domestic decline rates is evident in recent trends," Kieburtz wrote. "To achieve a 2.3% year-over-year natural gas production growth in 2006, the total rig count was required to rise by nearly 21% over the period, according to Baker Hughes. Moreover, we believe the rise in production is overstated as it is partly driven by an artificially low base resulting from hurricanes Katrina and Rita in 2005. The average number of producing wells rose by 20.6% over the period."

Nabors' Isenberg said Thursday that despite the recent drop in drilling, the company expects to have a good year.

"In Canada, lower activity and an early spring thaw are likely to result in an average of only 57 rigs operating in the seasonally peak first quarter versus 73 in the first quarter of last year," he said. "In our U.S. land well-servicing segment rig hours are substantially below expectations largely as a result of the ice storms in Texas, Oklahoma and California that occurred earlier in the quarter. Otherwise, the outlook for this business continues to appear healthy and we anticipate opportunities for moderate rate increases in selected regions as the year progresses."

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