Oil-Drilling Dayrates Falling; Utilization Rates Under Threat

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Add one more cloud to the storm front that has been threatening the oil-drilling segment.

Low oil prices have allowed oil companies to pressure the companies that drill and service their wells to bring their prices down. This pressure has become evident in the Gulf of Mexico jackup rig market, where the bottom dayrate ranges for certain high-end, or premium, jackup rigs have fallen by between $2,000 and $8,000 per day over the past four to six weeks. Premium jackup rigs typically drill in water depths of between 250 and 400 feet.

A more ominous sign for the drillers comes from a recent

Offshore Data

analysis of the jackup market that indicates demand for rigs may weaken late in the third quarter. Jackup rigs typically are contracted for short-term contracts, or contracts lasting 30 to 90 days, on relatively short notice. Until now, Offshore Data, which collects weekly and monthly data on oil rig rental and utilization rates, has seen no softness in utilization rates, or the number of rigs contracted at a given time. High rates of utilization are a sign of continuing demand for oil drilling equipment, and even with softening dayrates, have been viewed as a bullish indicator in the offshore market.

Offshore Data's "market overhang" analysis, which generates what the Houston company calls a "90-day overhang," tells how many rigs have no contract commitments after 90 days, says Tom Marsh, a drilling analyst at the firm.

In the strong drilling market of the past 24 months, the 90-day overhang has typically remained at between 40 and 50 rigs, Marsh says, but that number has ballooned to more than 70 in his most recent analysis. (There are 179 rigs that presently serve the Gulf of Mexico, 124 of which are jackup rigs, according to the Offshore Data's

Rig Locator

newsletter. The utilization rate in the Gulf is 95%.)

"That indicates to us there may be a possibility that there will be slackening of demand late in the third quarter," Marsh says. But keep in mind this analysis "is a moving target," he added. "If oil prices recover and companies decide they can bump up drilling activity a little, then all bets are off. What we'll be watching is what oil prices will be doing later in the year when

oil companies start thinking about their budgets."

"Every month we stay down there is another reason for oil companies to curtail spending," says Norman Rosenberg, an analyst who covers several major drilling companies at

Standard & Poor's

. "The prospect of slowing dayrate and earnings growth is a real cloud" over the sector, he says.

Marsh is quick to note that the dayrate decreases are not yet "a generalized phenomenon." On a percentage basis, contracts that are rolling over at $8,000 lower per day are rare, says Marsh.

The dayrate range for jackup rigs in the Gulf of Mexico is fairly wide, running from $20,000 per day to more than $70,000 per day, depending on the rig's depth capability, drilling range and equipment. Companies with large jackup fleets include

Ensco

(ESV)

,

Global Marine

(GLM)

,

Santa Fe International

(SDC) - Get Report

and

Rowan Companies

(RDC)

.

Oil prices, of course, remain the big "if."

Observers expected oil prices to firm after several major oil producing countries banded together and vowed to cut production back in March. Prices did leap on the announcement, to over $17 per barrel. Since then, however, overabundant supplies and high inventory levels have pressured prices right back to the $14-$15 range. Crude oil futures for July delivery settled Thursday at $14.85 per barrel, down 14 cents.

"It looks like the downdraft in oil prices since March puts pressure on second-half-of-year earnings," says James Stone, an oil service analyst at

Schroder

. Stone says that "there's a better than 50% possibility" some of his estimates will have to be revised due to the situation with dayrates.

As of May 22, the most recent date for which data is available, second-quarter year-over-year earnings for the oil service equipment group is expected to grow 22%, down from the 25% expected one month ago, according to

First Call

. Earnings growth for the drilling group, at 51%, stands unchanged from one month ago, says Chuck Hill, First Call's director of research. Looking at what analysts predicted for the drillers' second-quarter earnings growth back in January is more telling: As of Jan. 2, the consensus estimate stood at 70%.

Earnings growth of 50% in nothing to sneeze at, but even that healthy growth rate is down dramatically from growth rates of 121% and 142% the segment realized in 1997 and 1996, when the sector started coming back after a decade-long depression.

Analysts agree the recent deterioration in dayrates hasn't been significant -- at least not significant enough to affect second-quarter earnings.

"Right now the recent surge in dayrates has been interrupted, not stopped," says S&P's Rosenberg. Although he says he probably won't change his estimates for the second quarter, he'll be listening for contract status and what rigs will be rolled over when.

"I think any of the earnings revisions will be for 1999 and the second half of 1998," Rosenberg says.