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5 ways to tap into onshore drilling boom
Big oil and gas companies are looking onshore in the United States for oil and gas prospects for the first time in decades. These companies should benefit from all that spending.
By Jim Jubak
'Tis the season -- for oil companies to announce their budgets for drilling and exploration in 2006. And, if you're an investor in just the right oil service stocks, there may be a big surprise waiting for you: It looks like the big oil companies will be spending big bucks to find oil and, especially, natural gas in, of all places, the continental United States. The U.S. onshore drilling market is about to see its first growth cycle in more than 25 years.
Independent oil producers such as Forest Oil (FST, news, msgs) and super-majors such as ExxonMobil (XOM, news, msgs) have recently announced that they will reallocate their exploration and drilling dollars from international and offshore projects to the onshore market in the United States.
The focus of this new U.S. investment is the unconventional natural gas deposits in the Rocky Mountain states and in the Barnett Shale formation in north Texas. New technologies have made it possible to produce gas from the rock in these areas that couldn't be extracted before. Soaring natural gas prices -- futures prices in New York have doubled so far in 2005 -- have made it profitable to drill for and produce this gas despite the higher production costs of the new technologies. Add in the political factor -- producing natural gas in the United States doesn't present anything like the political risk of drilling in Nigeria or Indonesia -- and shifting capital spending towards the still largely untapped unconventional deposits in the United States is a no-brainer.
Drilling permit numbers are climbing
You can see the proof of this shift in the 24% increase in weekly drilling-permit numbers in the United States from October 2004 to October 2005. This pickup in drilling activity feeds through into higher prices for the scarce supply of land-based drilling rigs and for all the equipment needed for drilling and production. Spending on drill bits, for example, is up 24% for the first nine months of 2005 over the same period in 2004 and spending on pressure pumps and systems is up 28%.
Related news and commentary on MSN Money
The stocks of land-based drilling equipment and drilling service companies haven't had a bad 2005, but they have trailed their more glamorous off-shore brethren, where shortages of deepwater drilling platforms have sent day rates spiraling upward. A deepwater drilling specialist such as Transocean (RIG, news, msgs) is up 68% in 2005 (as of Dec. 6), while a land-drilling specialist such as Nabors Industries (NBR, news, msgs) is up only 48%. Over the next six months, however, I expect shares of the companies that sell land-based drilling services and products into the U.S. market to catch up as the story about the boom in U.S. exploration and production gets better known.
5 companies cashing in on onshore drilling
In my regular weekly appearance on CNBC's "Morning Call" on Dec. 7, I picked three stocks that will be primary beneficiaries of what I believe will be the first extended boom in land-based drilling in the United States since the 1970s and early 1980s.
Nabors Industries (NBR, news, msgs): Meet the king of land-based rigs in the United States and Canada. Nabors Industries owns almost 600 land-based drilling rigs and another 900 land-based work-over and servicing rigs. (The company also owns a relatively small fleet of off-shore rigs: 44 platform, 19 jack-up and 3 barge rigs.) That huge position in the land-based market gives Nabors big leverage from the current boom since the company's revenues and earnings climb as more rigs go to work at higher day rates. (Drilling companies charge for their services by the day.) In the third quarter, Nabors Industries had an average of 299 drilling rigs at work in the lower 48 states and Canada. That's up 22% from 245 at the end of 2004. Revenue per day from these drilling rigs climbed to $15,809 in the third quarter of 2005 for the U.S. rigs from $11,075 at the end of 2004, a 43% increase. Operating income per rig in the United States has climbed 190% since the fourth quarter of 2004, and the order book shows no signs of this trend coming to an end.
With the oil industry clamoring to drill in the United States again, Nabors Industries has announced that it will continue to put more of its idle rigs to work at a rate of about five to seven a month, and that it will build 100 new rigs by 2007. Within days of announcing the program to build new rigs, Nabors Industries reported customer commitments for 51 rigs that won't be ready for market until 2007. This sure doesn't look like the kind of rig building on spec that has crushed day rates in other shorter rallies. Wall Street analysts project that the company will grow earnings by 43% in 2006. The stock now sells at 12.8 times projected 2006 earnings per share. MSN Money's StockScouter stock rating system rates these shares a 10 out of a possible 10.
With Pioneer Drilling, you're trading rig numbers for rig concentration in the hottest U.S. drilling areas. The company's fleet of 52 land drilling rigs operates in the natural gas formations of Texas and the Rocky Mountains. That's less than 10% of the drilling rigs that Nabors Industries owns, it's true, but, with Pioneer Drilling's (PDC, news, msgs) regional concentration and its much smaller market capitalization ($841 million to Nabors Industries' $11.3 billion), the climb in day rates gives the stock plenty of leverage. (And the company has announced that it will expand its program to add new rigs to 13 from five rigs.) The first rig from what's known in the industry as a build program went into operation in October; the last is scheduled for delivery by the end of 2006. Twelve of the 13 new-build rigs are already booked under two-year contracts with day rates of between $16,000 and $18,000, according to Jefferies & Company. The company should also be able to cash in on higher day rates for its existing rigs since 13 of its current contracts roll over during the first half of 2007. Wall Street analysts project earnings growth of 217% for the fiscal year that ends in March 2006 and 68% for fiscal 2007. The stock now sells at 11.3 times projected earnings for the fiscal year that ends in March 2007. Our StockScouter stock rating system rates these shares a 9 out of a possible 10.
Grant Prideco (GRP, news, msgs): Somebody has got to make the things that go into drilling rigs, and in the markets for premium steel tubing and drilling products that somebody is often Grant Prideco. (The company controls nearly 50% of the drilling products market.) The company's order backlog climbed to $742 million at the end of the third quarter -- not bad for a company that did $946 million in sales for all of 2004. As a manufacturer with a high percentage of fixed costs, Grant Prideco should see earnings soar as volumes increase. Wall Street analysts project 209% earnings growth in 2005 and 48% in 2006. The stock now sells at 16.9 times projected 2006 earnings per share. Our StockScouter tool rates these shares a 7 out of a possible 10.
And as always, I have two more "exclusive" picks for readers of CNBC.Com on MSN Money.
Universal Compression Holdings (UCO, news, msgs): With most of the increased drilling activity in the United States and Canada focused on natural gas, Universal Compression Holdings should be seeing climbing demand and higher rental rates for its fleet of 7,200 compression units (which pump natural gas). And it is. The company will raise rental rates for its units by 8% in January 2006. Utilization of Universal Compression's fleet climbed to 91% in the most recent quarter from 90% in the same period a year ago. Weatherford International (WFT, news, msgs) has registered the 7 million shares of Universal Compression that it owns for sale. That block of stock is certainly a drag on the stock price in the short run. Wall Street analysts projected earnings growth of 45% in the fiscal year that ends in March 2006 and 20% for the fiscal year that ends in March 2007. The stock now sells at 17 times projected earnings for fiscal 2007. Our StockScouter rates these shares a 4 out of a possible 10.
Patterson-UTI Energy (PTEN, news, msgs) has the second largest fleet of land-based rigs in the United States to Nabors Industries and the second greatest number of inactive rigs that are gradually being brought back into service by the current drilling boom. The company plans to refurbish and deploy eight more rigs in 2005 and 30 more in 2006. That will bring the company's drilling rig fleet total to approximately 310. Patterson-UTI Energy's fleet is even more leveraged to higher day rates than the fleet of Nabors because 90% of its rigs are priced at spot rates that rise and fall quickly as market prices do. Analysts at Jefferies & Co. estimate that the company will see a $1,000 increase in average day rates in the fourth quarter of 2005. The company has told Wall Street that it expects to keep its rigs on short-term contracts to take advantage of rising day rates. That reduces the predictability of the company's earnings growth so Patterson-UTI Energy sells at a very modest 9.7 times projected 2006 earnings. Wall Street analysts project earnings growth of 231% in 2005 and 59% in 2006. Our StockScouter tool rates these shares a 9 out of a possible 10.
Editor's Note: A new Jubaks Journal is posted every Tuesday, Wednesday and Friday. Please note that Jubak's Picks recommendations are for a 12-to-18 month time horizon. See Jubak's CNBC Picks for shorter six month recommendations. For suggestions to help navigate the treacherous interest-rate environment see Jim's new portfolio Dividend stocks for income investors. For picks with a truly long-term perspective see Jubak's 50 best stocks in the world or Future Fantastic 50 Portfolio.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak did not own or control shares of any of the equities mentioned in this column. He doesn't own short positions in any stock mentioned in this column.
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