Skip to main content

As nervousness in the crude oil market simmers, onshore drilling contractors are inspiring the least confidence among investors.

Following a modest bounce in crude oil futures on Friday, prices dropped on Monday and were lower on Tuesday morning. Investors are focusing on bearish supply fundamentals (too much oil) rather than Iraqi tensions.

The ripple effect of the drop in crude, which has led several oil companies to issue gloomy warnings about spending levels, has led investors to question future earnings on many drilling fronts. As technological advances and more efficient drilling techniques have allowed oil companies to set their sights on large and potentially lucrative deepwater prospects, investors have followed, leaving the landlocked drillers behind. Thus falling oil prices are being felt most acutely in the land drilling segment.

Several land drilling contractors, despite small gains here and there, are down year to date as much as 49%. By contrast, deepwater equipment suppliers have surged as much as 18%, ahead of the

S&P 500's

year-to-date return of about 5%. And although many argue that the long-term outlook for the energy sector is bullish, lower oil prices are already affecting both the international and domestic markets. In the short term, the smaller exploration and production companies may refocus their energies on projects with a quick return on capital, or simply postpone certain projects altogether. Without a major bullish indicator on oil prices, rig utilization or dayrates, investors will stay away from the land drillers.

There are "clouds over the land drillers right now," says Scott Gill, an analyst at Houston-based

Simmons & Co.

"Add the weak commodity prices on top, and I think it makes investors more scared."

The first quarter is typically the slowest quarter for onshore drilling, as projects from the year before are wrapped up and new budgets are not yet implemented. But in a weak commodity price environment and after a great run-up in stock prices for much of 1997, investors scrutinize the slightest indication of weakening demand, whether it be a dayrate remaining stagnant or one rig not in service, as a negative signal. Case in point is

Nabors Industries

(NBR) - Get Nabors Industries Ltd. Report

. About 30 of Nabors' 200 rigs are idle right now, and even though "we're running as many or more rigs than we did one year ago at higher prices," says Dennis Smith, Nabors' director of investment relations, the stock has taken a major hit this year.

Despite a gain of 7/16 Friday to 22, the stock is down about 30% year-to-date.

UTI Energy

(UTI) - Get Universal Technical Institute, Inc. Report

TheStreet Recommends

has fared even worse. UTI slipped almost 2% Friday, to 12 15/16, and is down more than 50% year-to-date.

The stock prices of land drillers have been strictly determined by the price of the commodity, says Rob Shoss, an analyst at

AIM Capital Management

, whose funds owned just over 3 million shares of Nabors at the end of September, according to


. Although company policy prohibits Shoss from discussing specific stocks, he says he thinks the energy cycle has some length in it. "We're interested in fundamentals longer term," he says.

"Realistically speaking, if the price is not conducive, if the return on investment and capital is not there, it is not in the shareholders' best interest" for an oil company to continue with drilling projects, says Jack Aydin, a managing director at

McDonald & Co.

The fluctuations in the crude oil prices are much more likely to affect medium- and smaller-sized oil companies, and the companies that drill for them, since the majors have their spending plans set well in advance and the lead time for major projects could be a year or two. But there is "no question," he said, that cash flow for the smaller companies will be affected if crude prices remain sloppy. As a result, the smaller companies may switch projects around, and go for the projects with quick payouts.

Abraxas Petroleum

(AXAS) - Get Abraxas Petroleum Corporation Report

is already considering some switching. CEO Robert Watson says he is thinking about postponing some oil projects and speeding up plans on natural gas projects, as gas prices have strengthened in recent weeks. "Our outlook is still favorable," he says, adding that the company has not altered its strategy of strong production increases. "If most of our increases come from natural gas, that is favorable as well."

By now, everyone can cite the factors that have brought the price of crude down by rote, but there have been at least one or two positive notes in the market, says Mike Smolinski at

First Albany

. One is the strength of natural gas prices, which he chalks up to depletion. The second is heating oil inventory supplies being drawn down last week, "the first positive news the market has had in a long time." Nevertheless, investors are still spooked by the crude price drop and are now in a "show me" mode, he says.

In the short term, E&P companies may issue dire warnings, says Gill at Simmons & Co., but in the long term, if oil companies want to increase production each year, they will have to drill. Although companies may increase reserves and therefore production through acquisitions, "in the aggregate, the answer to get more production is you have to drill more wells."