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Unconventional Opportunities in the Oil Service Sector: Part II


With decline rates of 32% on existing production, I don't see how the land drillers won't be busy for some time to come.

Check out "Unconventional Opportunities in the Oil Service Sector: Part I"

One way to capitalize on the trend towards unconventional natural gas would be to focus on the service companies that provide the technologies that help unlock unconventional resources. Many of the unconventional wells drilled today decline hyperbolically. Initially, these wells flow at high rates but then fall off quickly and then produce at very low but sustained production rates (some for over 20 years). This is great for a quick payback, as high initial production helps a producer recover the cost of the well in a shorter period of time. High decline rates are an even bigger positive for the drillers as drilling must occur on a continual basis to replace reserves as they are produced.

Last week, I chimed in on the Buzz with the single most important reason I am bullish on natural gas on the long-term. Current natural as production in the United States has a decline rate of 32% and increases each year as unconventional natural gas production makes up a larger and larger percentage of domestic production. Replacing 32% of domestic production each year will require more drilling and technology from the oil service sector.

Since March of 2002, the gas rig count has more than doubled while domestic annualized production has continued to decline. The chart below shows annualized production of natural gas vs. the natural gas rig count.

Another interesting observation is the percentage of rigs drilling natural gas wells versus oil wells. According to data from the Baker Hughes, over 80% of active rigs are currently drilling for natural gas as opposed to oil. 20 years ago, less than 40% of active rigs were drilling for natural gas. Perhaps we should rename the Oil Service Index (OSX) the Gas Service Index.

The land drillers have been beaten down ever since topping out around January of this year. Record storage levels and fears of a bottomless natural gas price due to a warm winter kept a lid on the stock prices of those drilling for natural gas. While their stocks have languished, CEO's still talk of a very tight market and continued high demand for rigs. This is great for the large cap drillers such as Nabors (NBR) and Patterson (PTEN), and for some of the smaller cap land drillers such as Pioneer Drilling (PDC) and Union Drilling (UDRL). With decline rates of 32% on existing production, I don't see how the land drillers won't be busy for some time to come.
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Positions in UDRL and PDC

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