As Companies Move Towards Oilier Basins For Gas, Competition Will Increase; The Space Will Pause And Then ReAccelerate As 2012 Continues, Says Vice President At Raymond James

Wall Street Transcript

67 WALL STREET, New York - March 6, 2012 - The Wall Street Transcript has just published its Oil & Gas: Drilling Equipment and Services Report offering a timely review of the sector to serious investors and industry executives. This Oil & Gas: Drilling Equipment and Services Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Strong Demand for Higher-Specification Rigs - Drilling Shift From Gas to Liquids - Offshore Deepwater Oil Discoveries - Shale Drilling Dynamics

Companies include: Aker Kvaerner (AKSO.OL); Cameron International (CAM); Anadarko (APC) and many more.

In the following brief excerpt from the Oil & Gas: Drilling Equipment and Services Report, interviewees discuss the outlook for the sector and for investors.

COLLIN GERRY serves as an Oilfield Service Vice President for Raymond James & Associates, Inc., specializing in coverage of offshore drillers, manufacturers and diversifieds. He joined the firm as a Research Associate in May 2005, working with Marshall Adkins in the oil service group. Before joining Raymond James, he worked for National Oilwell Varco in a Project Management/Business Analyst capacity. He graduated from the University of Texas at Austin with a BBA in finance.

TWST: As you look at the space at this point, what does the demand picture look like?

Mr. Gerry: It's very high. I think that there are a couple of different trends going on right now. Clearly, you have a massive shift to horizontal rigs, and the only way to add capacity there is to build new rigs, and so that momentum is following through. We are stuck in a little bit of a quagmire here in which you do need to see dry gas activity come down, as gas prices have faltered so much, but that should be made up for with the oil activity. So a little bit of a water break, if you call it, in the overall acceleration of rig activity happening right now. And then if you go internationally, the outlook is very strong. Offshore you're seeing tremendous demand, great day rates for rigs. I think we actually are in a little bit of a low there too; actually, I think as we go through 2012 we are going to start seeing rig ordering activity on offshore rigs pick up.

TWST: Gas issues seem to be getting a lot of attention. Is that causing much of a dislocation, or is it shifting where rigs are being used?

Mr. Gerry: Well, I think that's the same thing. Dislocation is the perfect word. You're moving from the Haynesville to the Eagle Ford, to take an example, oversimplifying things, but that's what's happening. You're moving from the dry gas basins to the oilier basins. It's creating competition for some of the pressure pumping names and some of the ancillary services that go along with drilling in those oilier basins. But I think as the operator's cash flow changes suggests, I think you're going to see that those basins take a little pause here and then reaccelerate as we go forward to 2012.

TWST: You mentioned day rates. Are they holding up and allowing this picture to remain bright?

Mr. Gerry: Yes, land day rates haven't really moved all that much compared to completion pricing over the last couple years. The land market is very much a volume-driven market now, which the only real way to grow business is not necessarily by playing the spot market and waiting for day rates to go up like we've seen in prior cycles. It's more adding capacity, adding rigs. Hopefully, there's long-term contracts and that's kind of what's driving a lot of the earnings growth for these companies. Offshore there, you're seeing day rates go up, however. That's where you're seeing a more bullish day-rate environment.

TWST: As you look at the picture, is it likely to remain bright for some time?

Mr. Gerry: Yes, we're very bullish on the longer term for North America, as we think, in fact, so much so, we just lowered our long-term oil price, because we do think that you're going to see economics or such that you're going to continue to drill as much as you can. There's an almost infinite number of locations to drill in the U.S., and we're seeing it massively. Like we saw on the gas market, we're seeing in suppliers' bonds, the oil numbers for the U.S. are staggering now that we're reversing a 40-year trend of declining production. So I actually think that that makes a difference in global trade balances, but the only way to get there is if you drill. So from a long-term perspective, we are bullish.

TWST: You mentioned you've lowered your assumptions on oil prices. What are you looking at?

Mr. Gerry: Well, our long-term deck used to be about $125, on the premise that non-OPEC supply is rolling over, foreseeing a bigger draw on OPEC and squeezing their excess capacity back to levels we saw in 2008. The reality now is the growth in the U.S. that we think happens over the next five years in oil production is enough to actually grow non-OPEC supply such that excess capacity out of OPEC can actually grow. The exact opposite of our draw depends on OPEC going up, is happening. And so, yes, I think that is actually changing the global dynamic over the next five years, and it's a big deal. But the 90 number is interesting. The reason you compare is because if you get closer to 80, you start slowing down production and drilling in the U.S., and so that kind of - it becomes a self-regulated market. The thing bringing prices down to 90 is drilling in the U.S. And if you need at least 80 to get there, it seems like a pretty good number.

TWST: So 90 is your long-term look. As you look at the space, is there anything on the regulatory front that investors should worry about?

Mr. Gerry: Well, the Gulf of Mexico moratorium seems to be mending. It seems to be getting better. You always have to keep a watchful eye on the environmental stuff. And if you're going to ban fracking or something like that, frankly putting it, I don't think you can afford to do that. There's just too much job creation and too much economic incentive to continue to drill in the U.S. But certainly, there's nothing wrong with doing it safely, which I think for the most part we do. Other key regulatory issues, kind of struggling with some, I mean, there's a lot - the Keystone pipeline. I guess, but watching the environmental stuff on fracking and what's going on in the Gulf of Mexico, I think are the top two.

TWST: As you look at this space, are we going to see more M&A activity here? I know we're seeing a fair amount.

Mr. Gerry: Yes, I think so. I think you're going to see people much like Exxon (XOM)did with XTO, try to buy some natural gas reserves cheap. I won't be surprised to see that as we're flirting with $2.50 right now on gas curve. Longer term, companies - I think on the service side - you can always see consolidation. The frack market seems to have fragmented, and that could use some consolidation, same with the drilling market in certain cases. And there's always rumors of consolidation in the offshore drilling market. The numbers don't make, don't work quite as well sometimes, but yes, I think we'd continue to see M&A.

TWST: Is it going to be the big guys taking over the smaller ones for resource, or are we going to see combinations of some of the big ones as well?

Mr. Gerry: I would think the former. The big guys taking over smaller guys happens when you can make the deal economic based on accelerating capital. If you've got a smaller-cap company that has gold acreage, and it's growing the reserves in production. If you can get a big guy to step in and throw more capital at that acreage, really accelerate the development plan, that's where you get the economic incentive, which is kind of the environment we're in right now. It seems like big mergers of powerhouses is more of a cost-cutting endeavor that happens maybe in down markets. And it doesn't seem to me that we're in a down market right now.

TWST: What should people be looking at at this point?

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