March 9, 2008 / 9:18 AM / in 10 years

Oil patch drillers on the rebound

CALGARY, Alberta (Reuters) - After two bleak years, shares of Canada’ oil field service firms are rising again as buoyant natural gas prices get rigs back into the field.

Precision Drilling Trust PD_u.TO, Ensign Energy Services Inc (ESI.TO), Savanna Energy Services Corp SVY.TO, and their peers are now trading well above their early winter lows, backed by a new enthusiasm for natural gas as futures prices rise to two-year highs on cold winter temperatures and big drops in storage inventories.

“Natural gas prices on (the New York Mercantile Exchange) are now, on average, $10, the highest we’ve seen in a long time,” said Kevin Lo, an analyst with FirstEnergy Capital. “Everything is shaping up for a pretty decent 2008 and 2009 and that’s way better that what most people, including me, have forecast.”

Just a few weeks ago, there was little reason to be optimistic about the fate of the drilling companies.

At the end of January the Toronto Stock Exchange’s oil and gas equipment and services index .GTSX10101020 dropped to a three-year low as gas prices looked to have stalled around $7 per million British thermal units.

Around the start of the year, Canadian producers were threatening budget cutbacks because of the low price and fears that Alberta’s planned royalty hikes would raise costs.

Indeed, in late December, Precision Drilling units touched C$14.82, their lowest since June 2004, and Ensign shares touched $12, a level they hadn’t seen since June 2005.

Things have looked up since, though.

Precision closed on Friday at C$20.33, 37 percent above its low, even though its units have been trending lower since the last week of February as winter sets to end and the spring thaw keeps rigs out of the field.

Ensign was at C$16.87, racking up a 41 percent gain in less than three months.

“March has been a bit cruel, but that said, these stocks are up 20, 30 percent since bottoming in January,” said John Tasdemir, an analyst at Tristone Capital. “The drillers are seeing some light at the end of the tunnel.”

Drilling stocks are, by almost any measure, a bet on natural gas prices. Most of Western Canada’s gas wells are quick to deplete and producers must keep drilling to find new reserves to replace tired wells.

If gas prices are low, the industry steers clear, cutting back on drilling until prices justify the expense. That’s been the case for more than a year, with drillers often fielding less than half their available fleet.

But this winter the tide changed. After two years of mild temperatures that boosted gas inventories to record levels, this year has been colder and storage levels have dropped, pushing prices higher.

As well, Canadian production has sagged by almost one billion cubic feet a day because of the cutbacks, again lowering available supply.

Come the summer, gas could be in tight supply, especially if the weather is hot and power demand for the fuel rises while storage needs to be refilled.

The falling supply and potential rise in demand could be a formula for higher prices, particularly if crude says high. In that scenario, producers will look to ramp up drilling to exploit what could be a revenue windfall, absent significant imports of liquefied natural gas into the United States.

To be sure, any good times for the oil field service sector are relative.

The record gas prices that followed the devastating 2005 hurricane season in the Gulf of Mexico sparked record drilling levels in Western Canada. The service industry was fully employed and could push up hiring rates nearly at will.

Now, though, less than two-thirds of Western Canada’s drilling rigs are busy, according to statistics from the Canadian Association of Oilwell Drilling Contractors. That means the industry has little ability to increase profit by raising rates. That pricing power will have to wait.

“Before we really see a next leg (in stock prices) for some of the Canadian drillers, we need to see (rigs) getting back to work and utilization rates picking up,” Tasdemir says.

“We’ve got a lot of pickup to do before we start to see the earnings picture change for these guys.”

($1=$0.99 Canadian)

Reporting by Scott Haggett; editing by Rob Wilson

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