Oil, Gas May ‘Slingshot’ Up After Credit Freezes Rigs

By David Wethe

April 8 (Bloomberg) -- The credit crunch will keep U.S. oil and gas producers from ramping up exploration they do through drillers such as Nabors Industries Ltd., setting the stage for shortages and surging prices when demand recovers.

Chesapeake Energy Corp. and Carrizo Oil & Gas Inc. are among producers spending no more than their cash flow after a collapse in credit markets drove up debt costs. That means they won’t hire the likes of Nabors and Rowan Cos. to drill more wells in anticipation of higher prices. Producers cut capital budgets 17 percent this year after demand slowed and prices plunged, according to Tristone Capital Inc.

“Quite frankly, they don’t have the credit, which exacerbates the problem that their revenue stream is far below the cost structure,” said Jud Bailey, an analyst at Jefferies & Co. in Houston. “They’re not jumping on lower service costs simply because they can’t. They’re literally stepping away from anything they’re not contractually obligated to.”

The result may be a “slingshot” effect as spending cuts leave a supply shortage once demand returns, Bailey said. The number of active drilling rigs worldwide has fallen 35 percent from the 23-year high reached in September, according to Baker Hughes Inc. The U.S. rig count has plunged by almost half.

Houston-based Rowan, a drilling contractor that also builds rigs, said clients are delaying or canceling projects as they wait for service costs to follow oil and natural-gas prices lower. “Our customers are being quite vocal about wanting to reset their costs of operations in this currently low commodity- price environment,” Chief Executive Officer Matt Ralls told investors on a Feb. 26 conference call.

Stocks Plunged

Rowan, which had lost 70 percent of its market value in the past year before today, rose 56 cents to $13.05 in New York Stock Exchange composite trading. Nabors, based in Bermuda and run from offices in Houston, climbed 37 cents to $11.62. It was down 68 percent in the past year.

Most of Rowan’s rigs drill on land or in waters less than 1,000 feet (305 meters) deep. Nabors, the world’s largest onshore oil and gas driller, expects “substantially lower” earnings from land-based rigs through the first half of this year, CEO Gene Isenberg said in a Feb. 25 statement.

Of the 273 onshore rigs Nabors had working in the U.S. in October, more than 150 are now sitting idle.

Drilling originally stalled after a collapse in oil and gas prices from last year’s historic highs, said Dennis Smith, corporate development director at Nabors. U.S. crude-oil futures are down almost $100 a barrel from the record set in July.

Credit Squeeze

“The credit crunch might exacerbate it to some extent, especially the smaller guys that have no access to capital now from the conventional debt markets,” Smith said. “Generally people that are investment grade are still able to borrow, but they’re just being very prudent because nobody knows for sure where their cash flow is going to be.”

Deepwater drillers such as Transocean Inc. and Noble Corp. have fared better as producers go forward with large projects under contracts committing them to pay rig rents of more than $500,000 a day in some cases.

The credit crunch sets the current drilling slump apart from the slowdowns of 1997-1998 and 2001-2002, said James Wicklund, chief investment officer at Carlson Capital LP in Dallas. Exploration and production companies have more to consider than waiting for costs to come down, he said.

“The problem is instead of just waiting them out, they don’t have the credit markets to rely on this time to re- accelerate their drilling,” Wicklund said. “Before it was like, ‘OK, I’m going to wait until you drop prices by 20 percent, then I’m going to swoop.’ This time, the E&P companies have to live within cash flow.”

Awaiting Lower Costs

Houston-based Noble Energy Inc. is one of those producers looking for service costs to drop before resuming some projects. Chief Executive Officer Charles Davidson said he also needs to avoid contributing to a U.S. gas glut.

“It’s probably not the best time to be accelerating gas production,” Davidson said in a March 23 interview.

Just about all producers will be affected by the lack of available credit, regardless of how much debt they hold, said Subash Chandra, an analyst at Jefferies & Co. in New York.

“You’ll find over the last several years, pretty much everyone has borrowed to grow,” Chandra said. “Our industry on average has spent 130 percent of cash flow for a couple years in a row now. It’s kind of standard procedure.”

Oil Seen Rising

Schlumberger Ltd., the world’s biggest oilfield contractor, said a more prolonged slowdown in exploration and production spending will mean sharper price gains when the slump ends.

“The longer the period of lower spending, the more dramatic the falloff in production capacity will be and the steeper the recovery in oil prices once demand recovers,” CEO Andrew Gould said March 23 at a conference in New Orleans.

Larry Dickerson, CEO at Houston-based Diamond Offshore Drilling Inc., said he thinks global economic growth will be “substantial” coming out of the financial crisis, partly because of the industrialization of China and India.

“I think all the factors are certainly there to look at higher demand, and that’s going to be reflected in the price of oil,” Dickerson said in an interview.

Jen Snyder, head of North American gas research at consulting firm Wood Mackenzie Ltd., said she expects gas demand to recover at a slower pace than the economy because of new coal-fueled power plants opening in 2010 and 2011.

Even as service costs come down, making more projects look profitable on paper, some producers are too starved for cash or credit to ramp up drilling, said Wicklund of Carlson Capital.

“This is like all of a sudden, the price of Porsches has come down, but you lost your job,” Wicklund said. “It’s like, ‘Oh, well that’s great that service or Porsche costs have come down, but I still can’t afford it.’”

To contact the reporter on this story: David Wethe in Houston at dwethe@bloomberg.net.