Halliburton Co. is forecasting a "modest reduction" in the U.S. natural gas rig count through the rest of this year as operators remain focused on basins with "better economics," CEO Dave Lesar said Monday.

The CEO and his management team discussed the oilfield service company's 2Q2012 operating and financial results during a conference call with energy analysts.

"We believe that despite recent improvements in natural gas spot prices, downward pressure will continue throughout the injection season," Lesar said. "Oil and liquids-rich drilling has mostly offset recent reductions in gas rigs, and the majority of our customer base remains committed to previously stated activity levels. However, we believe that recent volatility in oil and softness in natural gas liquids may prompt certain customers to adopt a more cautious tone toward the timing of their drilling and completion activities."

In looking at the rest of the year, CFO Mark McCollum said it was difficult to see a "relatively flat rig count environment if commodity prices hold at this level for a significant period of time," said McCollum. "I mean, we think at some point here in the next quarter or two, the gas rig count is going to basically bottom out. And once that does, the oil rig count should be able to grow unfettered, which should provide some upside to it.

"The other side of it that we see also is the Gulf of Mexico recovery, which, again, as we look at the end of the year, should be approaching 40 deepwater rigs. We think our share is higher in this type of market than it was in the previous upturn and that provides some fairly significant margin uplift as well to the numbers that should help."

Halliburton's sequential revenues in 2Q2012 from 1Q2012 were "essentially flat," noted Lesar. The Canadian rig count dropped 70% sequentially on the seasonal spring breakup, while the U.S. rig count declined 1%. However, U.S. revenue grew 3% sequentially.

"We saw a continued shift from natural gas to oil-directed activity during the quarter," said Lesar. "The U.S. natural gas rig count declined 18% from the first quarter and is currently down 42% from its high in October of 2011. This represents a low point in the natural gas rig count over the last decade. However, the majority of the drop in gas rigs to date has been offset by an increase in oil and liquids-driven activity as our customers had shifted their budgets toward basins with better economics."

Spot pricing for hydraulic fracturing (fracking) in North American dry natural gas basins had been "under siege" in 2Q2012 but "it now appears to be leveling off in many cases because there are so few competitors left in these basins today," said the CEO. "We are also seeing increasing pressure in the oil and liquids markets as we negotiate the renewals of existing stimulation contracts and win new market share. In contrast, the majority of our other product lines continue to maintain relatively stable pricing."

Halliburton continues to add new equipment to North America to support its "Frac of the Future" initiative, he noted (see Daily GPI, Oct. 18, 2011). In 2Q2012 the company marked the deployment of its first Q10 fleets. "In the event that the market does deteriorate to where we are not earning our cost of capital, we would likely idle or retire older fleets and continue to bring new fleets out and build up our Q10 operations."

Today the company's frack fleets remain fully utilized. "Every truck we build is committed to a customer before it comes off the line. And where an existing customer has reduced demand for our services in a particular basin, we have been successful at displacing the competitor on other work for either that same customer or for a new customer we could not get to in the past.

"Our strategy in this environment has been and will continue to be to take advantage of our market position, differentiated technology, a more complete set of product offerings and the general flight to quality, which appears to be underway. Historically this has resulted in market share gains during the downturn, which we have positively then leveraged during the ensuing up cycle. We see no reason for it to be different this time, and our second quarter versus our competitors certainly bears that out."

North American operating income was down 19% sequentially, driven by guar gum cost inflation, the Canadian spring breakup, pricing pressures isolated to its production-enhancement product line; and efficiency disruptions associated with ongoing equipment locations from dry gas to liquids/oil basis. Halliburton had warned in June that its 2Q2012 North American operating profit margins would be 5-5.5% lower than in 1Q2012 because of higher material costs -- especially for guar gum. Operating profit margins in 2Q2012 dropped sequentially 4.8% to 20.7%.

The impact of the guar gum cost inflation was "dramatic," and is expected to continue to impact results through the rest of the year, said Lesar. Guar is a blending agent used in fracking fluid; 70% of it is produced in India.

About two-thirds of Halliburton's North America margin compression in 2Q2012 "was due to the impact of escalating guar costs, which rose approximately 75% from the first quarter. As we go into the third quarter, traditionally our busiest quarter in North America, we expect our total guar costs will rise an additional 25% over the second quarter as we work off our high-cost reserve and then costs should reduce as we close the year."

Guar pricing is expected to decline "but the situation is still volatile," said Lesar. "Spot prices for unprocessed guar splits fluctuated more than 30% just last week alone as the market reacted to the monsoon weather outlook. And depending on how the monsoon season plays out, our current excess guar supply may, in fact, become a strategic asset for us in North America if this year's crop falls short. But to help protect us against these issues in the future, we are actively developing alternatives to guar."

Net income fell in 2Q2012 from a year earlier to $737 million (79 cents/share) from $739 million (80 cents).

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