September 22, 2011 / 11:54 AM / 9 years ago

Analysis: For oil explorers, it pays to buy, not rent

(Reuters) - U.S. oil and natural gas producers are buying onshore drilling rigs and related equipment to keep their costs in check, rather than rent from oilfield services providers who have bumped up prices amid strong demand for work in shale fields.

With a 15-20 percent increase in the cost of land-based drilling, North America had the highest cost escalation in the past 12 months, said Pritesh Patel, a director at IHS Capital Costs Analysis Forum.

For nearly two decades up to 2008, exploration and production costs rose exponentially. That increase slowed in 2009 in the recession, but costs have risen again since.

While rig prices and production costs have followed a similar trajectory, the rise in rig prices has been far less marked. A rig today costs about as much as it did in 2008, according to Brian Uhlmer of Global Hunter Securities.

The rise in onshore exploration costs has been inflated by higher daily rates charged for scarce rigs, and the costs of fracking — a controversial process in which water, sand and chemicals are blasted into shale wells. This has hit margins and budgets at oil companies.

Oasis Petroleum OAS.N, Pioneer Natural Resources (PXD.N), Clayton Williams CWEI.O and Magnum Hunter Resources MHR.N have already bought rigs and other equipment as they look to trim costs and control their drilling activity.

Oasis Petroleum, which used to spend 30-40 percent of its entire well cost on pressure pumping, now has an in-house pressure pumping business in the pipeline.

“The broader overall economics of this decision are quite compelling ... Oasis can save $800,000-$1 million per well, gross,” CEO Tommy Nusz said on a conference call last month.

Oasis spokesman Richard Robuck said the company will spend $24 million this year on pressure pumping equipment and expects to have a 1-year pay-back.

Companies such as EOG Resources (EOG.N) and Range Resources (RRC.N) would also be better off buying their own rigs, analysts said, as they were adequately funded and have drilling potential for the next few years.

“Cost is a key consideration, but also just access (to equipment) ...” said Global Hunter Securities analyst Dan Morrison.

Chesapeake Energy (CHK.N), the second-largest U.S. natural gas producer, which in April agreed to buy rig owner Bronco Drilling BRNC.O, has said it wants to bring more of its services in-house.

Typically a company can re-coup the $20 million or so cost of a rig within two years, analysts say.

“Buying versus renting, that’s what it boils down to. If you have the money to buy, it will be cheaper than renting,” said FBR Capital Markets analyst Rehan Rashid.

IHS’s Patel said day rates for a land rig typically range from $28,000-$35,000, depending on specification. A basic rig of 1,500-1,700 horse-power costs $14-$15 million, with extra fittings adding another $5-$7 million.


“If you’re large enough to keep a rig running for several years, the theory is that you will save costs by running your own rig versus paying the day rate to a rig company,” said Neal Dingmann, an analyst at Suntrust Robinson Humphrey said.

Pioneer, which will own 14 drilling rigs by the year-end, expects total annualized savings of around $460 million, spokeswoman Susan Spratlen wrote in response to an e-mail inquiry for this article.

Spratlen also said Pioneer plans to add another 50,000 hydraulic horsepower of fracking equipment next year, and will look at expanding further if market rates remain high.

“A lot of the specialist services are limited in supply, and demand is increasing exponentially, so you’re going to see increases in the cost of services,” Patel said.

Midland, Texas-based Clayton Williams, which owns and operates 12 drilling rigs, said it is constructing two more which are expected to be operational during the third quarter.

“Owning our own rigs helps control our cost structure and provides us flexibility to take advantage of drilling opportunities on a timely basis,” the company said.

Magnum Hunter, valued at a little below $600 million, is looking to buy two new drilling rigs.


Companies expect higher drilling activities even if oil prices drop from current levels, and analysts said most will continue buying rigs and equipment as long as oil trades above $70 per barrel.

“The rig market is extremely tight, tighter than people realize,” said Dingmann at Suntrust Robinson Humphrey.

Ben Palmer, Chief Financial Officer at RPC Inc (RES.N), predicts the oilfield services market will remain tight over several quarters.

Owning rigs could also help oil and gas producers generate additional revenue.

“As E&P companies get a rig fleet ... and they don’t need the equipment, they can certainly sub-contract, and create some side revenue,” said Raymond James analyst Andrew Coleman.

Reporting by Swetha Gopinath and Vaishnavi Bala in Bangalore, Editing by Ian Geoghegan

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