Despite the 35% reduction in domestic drilling activity, drilling service costs have fallen only 15-20% so far because of consolidation in the industry. Today’s drilling and oil field service prices are 20-200% higher than during the same rig utilization in the last industry downturn, analysts at Raymond James & Associates said in an equity research note.

Much firmer prices are prevalent throughout the oil field service sector, including costs for supply boats, land rigs and offshore rigs. The drilling business has benefited from substantial consolidation over the past several years, including the merger last May of two of the largest contractors, Patterson Energy and UTI Energy.

The annual Reed Rig Census indicates that nearly two-thirds of the rig fleet today is held by players with 20 or more rigs each. Raymond James analysts said more than 75% of the rigs that matter (those that can drill deeper than 7,500 feet) are held by the top five players. “It is these top players that have taken an active role in stacking rigs over recent months in order to create a more rational and stable land drilling rig pricing environment.”

Land rig utilization in the fourth quarter of 2001 fell to 80% utilization, but dayrates were 32% higher than the last time utilization dropped to that level in 1998. And that trend is continuing in the first quarter of 2002. “As suggested by several drilling contractors, it appears that dayrates in this downcycle are likely to bottom somewhere near the peak in the prior (1997) upcycle,” the analysts said.

In the Gulf of Mexico, the rig count has fallen by more than 30% to 60% utilization, but pricing has dropped by only 25% to about 31% of replacement cost levels. The last time utilization was at this level, prices fell to 20% of replacement costs. In other words, prices are 50% higher than they were the last time utilization rates were at these levels. Consolidation has played a clear role in making this happen, but the transfer of rigs to international markets and a change to more deepwater rigs have been major factors as well.

In Canada, however, drilling contractors have started to implement strategies based more on improving utilization than rationalizing prices. “We know that some companies have already priced their rigs at cash costs or have implemented strategies that entice operators to use their rigs by offering them lower dayrates each day a rig is utilized,” the analysts said. “These strategies are obviously ones that focus more on market share than profitability.” Raymond James analysts suspect this strategy is designed to stymie growth of the rig fleet and open opportunities for further consolidation.

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