Get on the Right Side of the Rig Game - TheStreet

The energy market is rigged.

Don't go running to the

Securities and Exchange Commission

with that news because it's not what it sounds like; it's not fixed or unfair. But the recent strength in energy prices and the increase in exploration by companies like

Chesapeake Energy

(CHK) - Get Report


Devon Energy

(DVN) - Get Report

stands to benefit those who own the drilling rigs that provide the equipment that helps find new oil and gas opportunities.

I've opined a lot about the drillers

lately, but the evidence flowing in this week creates even more conviction that the future is bright for contract drillers. This is especially true for those with land-drilling exposure, like


(NBR) - Get Report



(PTEN) - Get Report

and others.

Consider the following data points:

Land market rig supply remains tight. Nabors says it can bring only about two new rigs to market each quarter, and that is with capital refurbishment of a minimum of $2 million per rig. After the next 10 rigs, the costs for rehabilitating older rigs for work will rise to $3 million to $4 million. For that type of capital to be committed, day rates will have to provide incentives.

International demand for drilling rigs is accelerating, creating competition for rigs that might have been available for domestic drilling in past years. Saudi Arabia is soaking up nearly two dozen new rigs in its attempt to quell oil production declines. Kuwait is bidding five rigs currently, with another dozen likely to be needed in the next two years. Libya will likely take 20 rigs in the next two years. Even Venezuela is said to be shopping for deep drilling rigs, so much so that Chavez is considering offering payment in U.S. dollars outside the country to cajole drillers to bring rigs to the Latin American country. Nabors suggests that there will be 45 to 60 rigs needed internationally over the next 18 to 24 months, rigs that will have to come from somewhere, probably the U.S.

Day rates and margins for drilling contractors appear to be expanding faster than most pundits, and even drilling companies, expected. Margins were roughly $3,500 to $4,000 per day per rig at the end of the fourth quarter. Nabors said sequential margins would expand in the $500 range in the first quarter. Others were more optimistic, suggesting expansion of $800 to $1,000. However, all those estimates appear conservative. Conversations with both exploration and production companies and drillers suggest that first-quarter per-day per-rig margins will be at least $1,000 above fourth-quarter levels, if not meaningfully higher.

Term contracts -- exploration companies agreeing to rig contracts for longer periods of time -- are becoming more common, many with significant margins. Nabors has a couple of term packages in Texas and the Rockies. A report surfaced this week that

Grey Wolf

( GW) signed term contracts for two rigs in the Rockies at margins of nearly $8,000 per day. That suggests additional strength is likely in rig pricing, bringing more margins and, as a result, better earnings to most of the contract land drillers.

While many pundits are beginning to argue that the energy complex is fairly -- if not fully -- valued at current prices, that assumes there will not be material revisions in earnings estimates. If day rates continue to accelerate and margins follow, you will begin to see earnings estimates for these companies revised meaningfully higher.

Some also argue that the recent stock sale by Nabors insiders is a sign that the market isn't likely to get much better. While you never like to see insiders sell, the Nabors sales are only a fraction of the executives' current holdings. And, interestingly, the last few times Nabors CEO Gene Isenberg has sold shares of Nabors, he has missed about 40% upside.

While the rewards of owning drillers have been solid, it appears there is still room to go. In this case, it may well pay to be on the right side of a rigged game.

Christopher S. Edmonds is vice president and director of research at Pritchard Capital Partners, a New Orleans energy investment firm. He is based in Atlanta. At time of publication, neither Edmonds nor his firm held positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. While Edmonds cannot provide investment advice or recommendations, he welcomes your feedback and invites you to send it to