Commodities prices are becoming top-of-mind around the globe. November contract West Texas Intermediate crude closed today at $87.34. Brent closed at $91.74, according to Bloomberg. Earlier in the day Oil & Gas 360® spoke to Jason Wangler, Wunderlich Securities Equity Research, discussing some of the points in his research note sent to clients today. Wangler covers E&P/Onshore Oilfield Services.
OAG360: In your note today, you said, “I guess we are contrarian because we like the $90/bbl oil and $4/mcf natural gas levels.” Why do you like those levels?
Wangler: I think $100 oil is too high. $4.00 gas and $90 oil is where we are. When you look at the E&Ps, all their announced drilling inventory, all their growth trajectories and particularly the funding ability they have right now—all that is based on $90 price levels, to maintain the activity level we see today. Plans will change dramatically if oil goes to $80 – $85. I’ve seen where Saudi Arabia needs $87 – $88, so they’re getting pretty close to break even.
OAG360: How sensitive are OilService companies to changes in commodity prices?
Wangler: They’re at the mercy of the E&Ps. The E&Ps are cyclical with oil. The service companies will earn revenue faster coming out of a down cycle because they’re just waiting for an E&P to call and tell them to get a drill rig working at their site, which takes 10 seconds. Heading into a down cycle it’s the opposite; service company revenues drop fast when the E&Ps stop drilling, but the E&Ps will continue to generate revenue from the wells that were drilled. For that reason, the service companies are a leading indicator of E&P growth. They start earning money before the E&P does, but they are a little more on the risk side.
OAG360: Which of your covered OilService companies have the best business models for working through commodity declines such as we have seen since mid-2014?
Wangler: Natural Gas Services Group (ticker: NGS). They just rent compression. Once you put compression on a well it’s there for 30 years. They’re not rig count driven. Their model hasn’t changed. It’s fallen with the group so I like that one a lot.
I also like Seventy Seven Energy (ticker: SSE), Chesapeake Energy’s (ticker: CHK) oilfield service company spinoff. It’s going to be tied in with Chesapeake’s E&P activities for a long time.
OAG360: What is the appropriate level of new build drilling rigs for the E&P space?
Wangler: Current domestic rig count is up 171 rigs from YE2013 to 1,922. We’re mostly replacing a lot of older rigs. About 1,000 rigs are pad-capable and we’ve only been building those for about 5-6 years; that’s about half the fleet. So there are about 900 older rigs out there. We are seeing about a 200 build a year, replacing the older rigs. That’s a good number. If they go much beyond that, the risk is on the service companies.
OAG360: In your note this morning you said, “What’s even more impressive is that the [rig] count is growing so nicely, even with the efficiency gains for OFS equipment/services really pushing the activity levels higher on a per-rig basis as well.” Are the efficiencies being driven primarily by pad drilling?
Wangler: A lot of it is just moving things around. If it takes a day or two to put a rig together and a couple days to tear it apart and move it, by leaving it intact on the pad you’re saving all those days. Even if you can save 2 hours, it makes a difference.
Also they’re getting more efficient at drilling these wells. If you’ve drilled tens, hundreds or thousands of these wells, you learn how to do it efficiently and you’re constantly fine-tuning to make it more efficient.
Zipper fracs are the newest thing being done to maximize use of equipment, but you can only do it if the wells are pretty close together, or a couple hundred feet or maybe a couple hundred yards apart. After you drill the well, you either use a workover rig or coil tubing to set the plugs, but you can’t have the frac equipment on the well at the same time—it’s only one or the other—so you’re paying for equipment that’s waiting. So somebody said, “What if we drill two wells [or four wells] side by side and we set the plugs on one at the same time as we frac the one next to it.” So you can go back and forth, setting the plugs and using the frac equipment at the same time on different wells and then switch. On a pad you’ve got hundreds of trucks and a ten story drill rig and a lot of other equipment all working on a couple of acres. It’s all about learning how to minimize downtime.
OAG360: You talked about the need for more gathering and processing systems as well and short- and long-haul pipelines in today’s note: “This bodes well for companies like MasTec, Inc. (ticker: MTZ), and Primoris Services Corp. (ticker: PRIM), given their construction capabilities as we enter a potentially multi-year cycle of build out.” Could you expand on that?
Wangler: On the infrastructure side, companies like Kinder Morgan (ticker: KMI) and Enbridge (ticker: ENB) and others have significant plans for the next 3-4 years. I look at 2014 as a year for engineering and permitting for major pipelines and other infrastructure projects and 2015, 2016 and 2017 are going to be the build-out years.
OAG360: What are OilService companies doing with their Master Service Agreements to retain and support their E&P customers?
Wangler: On the completion side, a lot aren’t signing very many now. The service companies aren’t looking to sign long term deals because they don’t like the pricing and those contracts can be broken if the E&P wants to. On the drilling rig side, the 3-year contracts are in demand and popular, for the brand new rigs especially.
OAG360: Any thoughts on the rumors of Pioneer Natural Resources (ticker: PDX) selling its Eagle Ford assets?
Wangler: If they want to focus on the Permian, it’s a good way to add $3-$4 billion cash in order to do that.
OAG360: Thank you for your time.
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