Brian Uhlmer: Drill Bits
Source: Brian Sylvester of
Large oil-drilling projects in the U.S. and abroad, the price
of oil and new drilling technologies have brought growth and
stability to oil field services and equipment companies. Read why
investors are looking at this sector in
The Energy Report's
exclusive interview with Brian Uhlmer, managing director and
senior analyst of Global Hunter Securities' Energy Group.
The Energy Report:
How long has Global Hunter Securities been covering the oil field
services and equipment sector?
For about a year.
What was the reason for getting into this particular sector?
The founder of our firm really knows both the exploration and
production (E&P) and oil service sectors and has strong
What is your strategy with the sector?
We try to pick stocks well; Global Hunter looks for good,
investable names with quality management teams and long-term
secular growth. We distribute research on the best companies in
the space. We are in Houston and on the ground talking with
management teams, as well as middle management, customers and
suppliers. We really understand every detail of the sector.
Is the growth in the oil field services and equipment sector
coming from the increase in the oil price, or are there other
significant growth catalysts?
The majority of the growth is coming from oil being above US$70 a
barrel (bbl). Once we broke US$70 and people believed the price
would stay above that for an extended period of time, long-term
investment and project decisions were made. That meant capital
equipment was ordered with a two- to four-year lead time. Drill
programs have been started, and it's not just drilling a couple
of wells and producing them-it's developing full fields. That's
really led to improvement in the long-term story for the service
sector. These oil prices prompted the development of oil fields
in the U.S., as well. Having oil developed here so we can do
something to decrease our reliance on foreign oil has led to a
secular uptrend on U.S. land. And that's been affected by oil
prices being high.
With oil well over US$100/bbl, are increased margins finding
their way down to the oil services companies?
Not necessarily. It's a slow-moving process getting equipment
back to work. You've got to have equipment that's highly utilized
to get the pricing power needed to expand margins for oil service
companies. It's really company specific; several areas of oil
services have seen pricing improvements beginning in late 2010.
They're starting to accelerate a little bit in 2011 and taking
some of that margin away from E&P and putting it into their
In other segments, most notably the offshore sector, day rates
have not accelerated or moved upward in that space. There is
still a lot of capacity that was sidelined during 2009 and is
slowly getting back to work. It's more a factor of the long-range
forecast versus the current spot price of the commodities.
Can you compare the history of oil services and equipment
companies with what you expect in the future?
The last 30 years have been highly cyclical for oil services,
especially with companies levered to North America and to land
plays. The offshore market has been like that as well, with
short-term contracts and high cyclicality. You've seen margins,
revenues, everything, go up fast and go down fast, with the
stocks seemingly reacting the same way. As we moved through this
cycle, beginning in 2007-2008, we started to see a lot more term
contracts for offshore and land, with some growth in the mega
projects. With those, we have a lot more stability in terms of
revenues, margins and earnings because they are long-term
projects. Then there are incremental margins, upward or downward,
for short-term contracts. In the U.S., we've seen mega projects
We've got larger operators saying, "I'm going to develop this
full field, whether it's in the Marcellus or Eagle Ford Shales,
the Bakken, or the Permian Basin. I'm going to make a plan for
multiwell packages. I'm going to contract my rig for two to three
years. I'm going to contract my service provider for two to three
years to complete that program. I'm not picking up the phone and
saying 'come out and drill this well today,' and then letting the
rig go as soon as that well's done.
Are the small margins of E&P companies eating into the
margins of oil field services and equipment companies? Or are
there so many of the latter that they can set their price and
explorers and producers (E&Ps) have to meet it?
At this point in the cycle, the service companies have more
leverage than E&Ps. There are equipment shortages and premium
rates, premium-pressure pumping equipment and access to high-tech
services for horizontal drilling. So, with any of the more
difficult wells you're drilling, the service providers absolutely
have the leverage right now.
How long do you expect that to last?
The rig count is increasing and is expected to continue rising
over the next 12-18 months. We expect that to continue through
the remainder of 2011 and into 2012. During this cycle, a lot of
the equipment and service providers haven't built much new
equipment on speculation. They have told the E&Ps that if
they want something built, they have to sign it up for a
long-term contract. That is keeping excess capacity from entering
Also, the economies of scale are large this time around. A
premium rig is going to cost $18M-$20M. Previously, you could
build a rig for $4M-$5M. A smaller company could build rigs back
then; now, you've got to be fairly well capitalized. A
pressure-pumping crew will cost almost $40M. It's no longer a
couple of trucks for around $2M. You need a full crew of 15
trucks and a lot of ancillary equipment that costs a substantial
amount of capital. Many of the smaller service companies are out
of business and do not have the ability to get back into the
So, these companies need to be big just to compete?
Yes, absolutely-not huge like
Halliburton Co. (
, but big enough to get $40M-$100M together.
Is the stability coming from development of shale plays?
Absolutely, without a doubt. You've got tougher wells, deeper
drilling, longer lateral length, more complex tools and higher
intensity. You use a lot of service intensity, such as the number
of trucks and people needed on site. A well is not a $300,000 or
$400,000 event anymore-it's a $4M-$10M event because the service
intensity is so high. Horizontal drilling and high-pressure
hydraulic fracturing (fracking) have led to a large increase in
service intensity. That's how we're getting the hydrocarbons out
of the shales and tight sands.
Do you think the current backlash against shale plays near urban
areas will slow down the demand for oil field services and
No, because there's enough in rural areas. The big areas of
growth, such as the Bakken, the Permian Basin in Texas, the Eagle
Ford Shale in South Texas and the Niobrara Shale in the Rockies
are fairly remote. Shale plays are an issue in New York state,
Pennsylvania, the Marcellus and the Barnett Shale in Fort
How many oil field services and equipment companies do you cover,
and how do you determine which ones are worthy of coverage?
Nineteen. We find stories that are not followed by a lot of
people or where we have found a differentiating opinion or point
through our knowledge of their customers, suppliers or management
teams. We only cover companies that have high-quality management
teams that we can trust. Sometimes, we may end up with a Sell or
Neutral rating based on valuation metrics; but we always trust
that the management team will do what's in the best interest of
the shareholders. We won't cover a company unless we believe that
Tell us about
National Oilwell Varco (
NOV is a large-cap manufacturer in the oil service space. The
post-Macondo shakeout has meant operators want the newest, best
and highest-tech equipment for two primary reasons. The first is
safety. Nobody in the oil and gas (O&G) business wants to be
unsafe. Nobody wants a well to blow out. Nobody wants to pollute.
We all have families. We all believe in protecting and being good
stewards of our environment. Therefore, as we see step changes in
technology that can improve the safety of our operations, there's
going to be a big push toward investing in that equipment.
Second, increased efficiency comes with this newer equipment-it's
faster to move, bigger and drills faster. Whether a land rig or
an offshore rig that jacks up on the water or a
that's $600M-$650M, they've all improved safety and efficiency.
Over the last five years, there have been technological changes
to the way equipment performs operations, how fast it works and
how safe it is.
Are you saying it's somewhat of the antithesis of
Transocean Ltd. (NYSE:RIG; SIX:RIGN)
Absolutely not. I mean NOV manufactures the rigs that Transocean
will use. The Deepwater Horizon rig was a 10-year-old rig. It was
a high-quality rig. There were a lot of other events that led to
the Macondo disaster; however, since that occurred, nobody wants
to take a risk on an older rig where the potential for something
unsafe to occur exists.
So, NOV is building these new, bigger, more efficient, faster
Absolutely. The company receives about $200M of the $600M total
bill per offshore rig ordered. We've already seen a fairly
sizeable amount of rigs ordered in the past six months-around 40
floating rigs and another 40 or so
. With the jack-up rigs, the company gets anywhere from $25M-$65M
out of the $200M billed. The same can be said for the land rigs
targeting the shale plays, specifically. You need a bigger,
sturdier rig and it needs to be quick moving to get from well
site to well site. Those rigs cost about $18M to $20M apiece.
We foresee NOV getting orders close to 100 rigs this year. So,
operators have expressed interest in ordering new rigs. Some of
them have signed letters of intent with the yards that build
them. Because NOV is an equipment supplier, it doesn't actually
build the steel-it supplies all of the equipment. We've seen
those orders with the yards and that will flow down to NOV over
the next couple of quarters.
NOV's management has built the most dominant rig-equipment
supplier in the world over the last 10-15 years. They've bought
up their competition and engineered new designs, so they're the
highest-tech company. They've positioned National Oilwell Varco
and it's garnered almost 70% market share in the floating rig
market, in terms of rig equipment.
Let's move on to another company called
Pioneer Drilling Co. (
Starting in mid-2008, Pioneer Drilling bought a well-servicing
and wire-line company, paid a nice price for it and used its
revolver to purchase it. There was a fast economic downturn right
after that. Pioneer spent all of 2009 making sure it stayed in
business. In 2010, the company put permanent financing on its
books. The company didn't have
issues and was able to use some money to upgrade its rig fleet.
Moving through 2010, it turned out that the 2008 acquisition
actually was of very good equipment and provided the foundation
for a solid well-servicing business.
All of that equipment has been operating at close to 90%
utilization. It also has seen pricing increases through 2010. As
we move through 2011, it's still at full utilization. Pioneer now
has a balance sheet that allows it to add new equipment and build
its fleet. The company is adding this new equipment into a very
hot market in well servicing and has built new rigs targeting the
Permian. It also has some mid-tier rigs that aren't the fastest
moving and best rigs for the shale plays; but, in the Permian
Basin, you don't necessarily need the Cadillac or the Rolls
Royce-sometimes a Ford F150 will do the trick.
That market has seen accelerating day rates and dramatic
increases in utilization over the last several months, and that's
anticipated to continue. All of the E&Ps in that area have
stated their intent to add rigs. They're willing to add these
middle-of-the-road rigs throughout 2011, and we expect that to
continue into 2012. The Permian Basin is an oil-directed play. As
long as oil is holding above US$75-$80, we see no reason to slow
down drilling at all. They are going from negative earnings in
2009 and 2010 to positive earnings in 2011. They may triple their
earnings in 2012.
What's the competition for Pioneer Drilling in that segment of
It's a fairly competitive market. During 2009 and halfway through
2010, that rig count was very, very low. We did see quite a few
bankruptcies and rigs laid down that have not come back to work.
The competition is actually a little bit less than it was in
2007-2008. They are standard, mid-tier land rigs, which are not
differentiated products. It's really a factor of the lack of
available equipment-people are not building these rigs; they
aren't state of the art. A lot of the older ones were laid down
permanently in 2009-2010 and aren't active on the market anymore.
Utilization is breaking 80%, which leads to pricing power.
What is the typical utilization rate for most companies in this
It varies by company. Right now, the average for the marketed
fleet is about 86%, which is fairly high. Once you break 90%,
you've got a very, very tight market. When you're kind of in the
low 70s, the market is perceived as loose. You're not going to
get any day-rate improvement; you cannot charge more for your
equipment because customers know there's plenty of other
equipment out there.
Some of these companies have a 60% utilization rate. However,
in the rig classes that matter, such as the higher-end rigs, it's
80%-90%. While some companies may have 60% utilization, in the
decent equipment category, they're in the mid 80s. We consider
anything over 80% very strong.
You mentioned there is a new build? Is that a brand new piece of
Yes. It's a new rig.
Are there such things as rebuilds?
You can retrofit rigs.
So, a brand new rig costs an estimated $15M-$20M?
Yes. And, that's what NOV is building. Some companies add pieces
of equipment to help drilling in a horizontal place, such as a
top drive or a bigger mud pump. Also, you can upgrade the steel
so it holds more weight and can drill with heavier drill pipe or
a bigger casing. Older rigs can be retrofitted for several
million dollars, which can adapt them for some jobs.
One other company that you have a report on is
Xtreme Coil Drilling Corp. (TSX:XDC)
. How is this company a good story for investors?
Xtreme Coil Drilling is a company that is somewhat
differentiated. Xtreme designs a rig that has a coil tubing unit,
drill pipe and top-drive drilling capabilities, and then has the
rig built. You can use those in the same well, which is
beneficial when you're out in the field. Drilling with cool
tubing is done on almost half of the holes in Canada, but it's
not done a lot in the United States. It hasn't been accepted for
a variety of reasons.
This company is starting to put rigs to work in the U.S. Much
of it is drilling with drill pipe but it has the tubing on the
rigs, as well. When there is a need for it, the company will
actually end up using coil tubing and building the résumé out as
a dual-purpose rig. No other drill company in the U.S. has that
capability. Xtreme Coil Drilling and
Baker Hughes Inc. (
have taken this technology over to Saudi Arabia, and the two rigs
have reported very strong results when compared to its
Xtreme is expanding its international footprint, doing it with
a high-quality service provider and working for Saudi Arabia's
state-owned national oil company-Saudi Aramco, which is the
biggest oil company in the world. The company is building a very
solid resume with some well-capitalized customers, who have
strong growth ahead of them and should be able to continue to add
to their rig counts. In the U.S., Xtreme's largest customer is
Anadarko Petroleum Corp. (
, another very well capitalized company with lots of drilling
programs on U.S. land.
What are some rules of thumb for investing in the oil field
services and equipment sector?
I think the number one rule is to make sure that you've got a
top-quality management team in which you believe and have
confidence. The number two rule is to remember that, overall, the
sector is pointing up and to the right. Don't be scared that the
stock prices have accelerated fairly quickly over the last
several months. These companies spent that last two years
fighting through the pain and have really leaned out their
operations, manufacturing processes and supply chains.
As they add orders to their backlog, we should see fairly
rapid improvement. We've got good capacity availability, good
lean operations and strong supply chain management. We've got to
look at U.S. land as a secular play-not a cyclical play. It has
always been a boom-and-bust cycle for these companies. While
you'll have ups and downs on pricing for services based on
capacity and utilization, overall, you're going to have stronger
earning power throughout the entire cycle. We've taken a step
upward. That's primarily due to new drilling technologies and the
re-emergence of oil in the U.S. that we can drill and produce to
support our own oil demand in country.
Thank you for your time.
Brian Uhlmer is managing director and senior analyst of
' Energy Group. He has more than a decade of relevant energy
industry experience, most recently as director of research and
senior oil service and engineering and construction analyst with
Pritchard Capital Partners, where he covered companies ranging in
market capitalization from $100M-$20B and was responsible for
commodity price forecasts. He developed the
Pritchard Morning Note
layout, Weekly Rig Count note and other new research
products. Uhlmer is a lifelong energy veteran, growing up in
Australia, Malaysia, London and New Jersey as the son of a
30-year Esso employee. He received a BS degree in chemical
engineering from the University of Florida and worked for
Halliburton, KBR and Sifco in engineering, and then business
development roles. A U.S. Navy veteran, he holds an MBA from the
University of Texas and is a CFA charterholder.
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1) Brian Sylvester of
The Energy Report
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