Dec

31

There is an interesting divergence in the stock prices for offshore drilling and land-based drilling companies. Both are in the business of looking for energy.

In the past the two appeared to be more in step with each other as the price of oil fluctuated. Then came the (over)realization that the land-based drillers' objective is mainly natural gas. As natural gas reserves increased and natural gas prices went down, and the fear of recession and "global warming"/warm winters set in, the land-based drillers were sent to the "dog house".

But natural gas companies have an insatiable need to keep replacing reserves as they deplete quite quickly. Land-based drilling objectives have become much deeper and more technically difficult (i.e. horizontal drilling techniques) so it is not as easy to drill one well and move to the next quickly. And if there is a fair amount of cold weather this year there could be a significant drawdown on natural gas reserves going into next year.

Based on the cyclical nature of these stocks, past volatilities and recent quiescences, Wall Street's past infatuations and scant notice these days, future assumptions, and the limited supply of available, quality rigs, I wonder if there is some testable criteria (I have seen historical PE ratios used in the past as a point of reference) that would allow one to determine if the land-based group (and really only 5 companies are the owners of the majority of the land-based rigs in the US) is a good value at this point. It is a speculative area with many, many variables and quite risky at times.

In other words when is it a good time to go bottom-fishing and can that be determined for a particular industry group?

As a thin reed there appears to be a sharp increase lately in the hiring of geologists just out of school–at this point, however, it is probably due more to offshore petroleum-related work.

David Lamb adds:

As an addition to this discussion I asked my neighbor, who is a Reservoir Engineer for C*n*c*Phi!!ips, to add his two cents. My neighbor's comments:

"…give me a day or so and I will send you what you need to have a big picture - clear understanding of this and the oil gas industry as a whole (which is largely misunderstood by speculators right now). The mass hiring of geologist and engineers in general is absolutely true -this is a result of what happened in the early 80's where most petroleum engineering programs were closed as a result of diminished student interest. When OPEC reduced supplies in seventies - students flocked to petroleum engineering and US oil companies began drilling and producing at max levels. Rig counts reached double what they are today. When OPEC released its supplies in the early 80's there was a surplus of oil on the market and oil prices plummeted. Rigs where no longer economical and mass lay offs by the oil companies ensued. College graduates could not get jobs in the petroleum field and as a result interest by prospective students diminished.Nation wide the number of Petroleum Engineers graduating with a bachelors was reduced to the 200 a year range. Note that this took place in a time when the supply could meet and exceed worldwide demand for oil.

Worldwide oil production has remained relatively constant while the number or wells drilled yearly to meet this production is constantly increasing (this means we are now drilling more wells for less reserves and at higher costs than the wells of the 70's, 80's, and 90's). In the meantime worldwide demand has continued to increase. India and China demonstrating the largest increase in demand. With new competition in the worldwide oil market prices have soared from around $10 a barrel in the early 80's to near $100. Pure increase in demand and constant supply economic response. In the meantime - the petroleum industry engineers have aged, very little influx in new engineers since the late 70's. Therefore 70% of the current petroleum engineers and geologist are expected to retire with next 10 years. Petroleum engineering school have not however been able to increase there enrollments until the last few years. Therefore, there is not enough engineers graduating to replace the retiring force. Therefore, huge recruitment pushes have been made in the last few years with large salaries and signing bonuses to capture what engineers are available. I received 8 job offers with the lowest offering 70K and bonuses all months prior to my actual graduation. Geologist have seen some of the same trends although they have a larger pool of graduating students. Typical geology graduates with a bachelor could expect to make 35-40K but within a oil company they can start at 65-80K. Most large companies still require a masters in Geology for exploration and heavy drilling work. However, all drilling rigs employ a mud logger (geologist) to examine the drill cuttings as they come up during drilling to identify rock type, formation, ect. These loggers are in more demand lately as well and so salaries have risen from base to decent wages. In addition the type of drilling being done today requires much more technical understanding of rock formation and reservoir interpretation. Previously, vertical wells required very little geological interpretation. Now directional and horizontal wells require full time geological monitoring at costs sometimes exceeding 100 Million a well.

Many companies are offering huge signing bonuses (100K +) for experienced engineers (3+ years) to leave there current company and come to work for new company. Because the number of new Petroleum engineers is insufficient to fill new demands the petroleum industry has begun hiring all types of engineers and doing on job training in petroleum (these engineers receive base salaries above what they can expect working within their own field). Currently petroleum engineers receive the highest avg. salary of all engineers.

In short what we are seeing is that the amount of oil available is high, however it is in reservoirs that were uneconomical to drill at lower oil prices. However, the rate at which we can extract oil from these reservoirs (oil sand, heavy oil, deep offshore) is very limited. Therefore, although we are not looking at running out of oil in next few centuries we will likely never be able to increase actual available supply while demand should continue to grow. Unlike early 80's no one has capacity to flood market with additional supply. China and India will continue to provide more price competition for available oil and therefore Prices will continue to rise and this will negatively impact US standard of living.

Ethanol, Hydrogen cells, ect. are not viable replacements and will not be in near future (despite what the green movement would like you to believe). These technologies also require the input of large amounts of oil based energies to produce and this is rarely mentioned.

Natural gas supplies are huge. Traditionally much of the produced natural gas has been flared or reinjected back into the earth due to the lack of transportation piping available and the low costs per MBTU of gas. This continues to be true to some extent. Canada, and the U.S. have huge reserves that are not all being currently used due to cost of building gathering systems and low prices. New technologies are being used to convert natural gas to LNG (liquid natural gas) for transportation and marketing purposes. These plants cost 10's of billions and take years to build. In the future these LNG's will replace some of the oil demand and can be used and burned similarly. The natural gas stores in China, Russia, Middle East, and other places have not even began to be used and are large enough to supply worldwide energy for hundreds of years if they could be drilled and transported to the market place. These supplies will continually suppress the natural gas prices - as prices try to go up, new reserves will be tapped and increase supply and maintaining price.

The number of drilling rigs in the U.S. has continued to increase in the U.S. over the past 5 years or so. The number of rigs is still about half of the number achieved in the 70's. These rigs are drilling more complex and time consuming wells than the past and onshore drilling is focusing more and more on natural gas reservoirs.

Offshore gulf coast drilling continues to focus largely on oil but cost are huge and returns risky.

here are a few links that may be of interest. I will also send you a few additional charts that may help predict future commodity behavior."

Rig Counts

Oil Long Term Supply and Demand

International Energy Outlook 2007


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