Market Outlook: Are We Heading for a Multi-Year Upcycle?

By John Daniel, Daniel Energy Partners

With the Russia/Ukraine conflict continuing to escalate, to say 2022 is off to a bang is an understatement.

Oil prices are hovering well north of $90/barrel, so the importance of energy independence is once again a legitimate discussion topic. However, Wall Street’s call for E&P capital discipline rings as true as ever as investors continue to demand free cash flow versus production growth.

Consequently, the meteoric rise in crude prices does not necessarily manifest itself in a potential meteoric rise in domestic oil and gas drilling and completion activity. At least, not yet. Thankfully, commodity prices have steadily recovered from the COVID-2020 lows due to a global rebound in demand as well as moderating oil inventories.

This improvement allowed domestic drilling activity to rebound throughout 2021 from under 250 rigs in late 2020 to a healthier level of 635 rigs as of late February 2022 (using the Baker Hughes U.S. land rig count). No doubt a 400+ rig count gain is impressive, but the outlook near-term is somewhat tempered due to continued E&P capital discipline.

Presently, we foresee the U.S. rig count rising to as many as approximately 700 rigs by year-end 2022, a more than 10% rise from today. Near-term visibility is clear as all the leading land drillers cited on their recent earnings call an expectation of higher rig counts in the coming weeks.

Completion activity, meanwhile, is stable-to-slightly improving as sand and logistics issues, not to mention labor challenges, limit near-term upside to the U.S. frac crew count. In fact, most of the leading public pressure pumping companies foresee only a modest improvement in effective utilization in Q1 2022 versus Q4 2021.

Completion demand should, we believe, improve heading into Q2 as some of the supply chain and mine-related issues are resolved. We anticipate the active U.S. frac crew count rising from the approximately 240 range to 250-260 fleets later this year.

For the U.S. well service sector, two important variables exist. First, high commodity prices provide great incentive for operators to keep older wells pumping, thus demand for production work should remain robust. Moreover, as production work often does not hit an E&P’s capital budget, the ability to allocate more money to production-related work should, in theory, be easier.

Second, the U.S. well service industry is finally witnessing much needed industry consolidation as several legacy-leading businesses have now been merged into other enterprises (i.e., C&J, Basic, Forbes, Superior and Nine). This consolidation process is a critical step for remaining larger players to leverage cost synergies, but also to address what has for many years been a supply/ demand imbalance.

And while we cheer consolidation, more is needed as legacy rigs, many from defunct companies, are now being sold/auctioned and recirculating back into the market. In fact, several industry contacts report a growing number of small players, particularly, in the Permian are now emerging, most with three or less rigs. A viable business model? We’ll see, but for E&P companies simply chasing low bid, the rise in competition might play well to such a strategy.

On the other hand, larger players continue to report efforts to increase rig rates as stronger financial returns are a necessity to remain a going concern. More money, understandably, is required to reinvest in a depreciating asset base as two years of industry equipment neglect is/will become an issue.

Thankfully, rig builders report a rise in remanufacturing and Cat 4 inspections with backlog for both now growing. In some cases, rig builders are building rigs on spec given a belief in higher returns may result in either existing or start-up players seeking new equipment. But before the industry can press the accelerator on newbuild activity, further price increases will be required as inflationary cost pressures abound. Thus we foresee a continued effort by the industry to push pricing. This means returns for the sector should improve.

As for forecasting the outcome of today’s geopolitical events, that falls well outside the Daniel Energy Partners’ comfort zone. Nevertheless, with Q4 earnings season in the rear-view mirror and with the benefit of numerous 2022 E&P capital spending budgets now made public, visibility and outlook for 2022 both seem strong.

Beyond this year, that’s anybody’s guess, but the overall belief within the vacuum of the U.S. upstream energy complex is the prospect for a multi-year upcycle. The oil futures curve, which has oil prices above $70 barrel through 2024, would lend credibility to this view. However, as 2020 taught all of us, weird and unexpected things can happen, so best to be prepared.

John Daniel

John Daniel is the Founder and CEO of Daniel Energy Partners. Prior to founding DEP, John served as a Managing Director and Senior Research Analyst with Simmons Energy, A Division of Piper Sandler, covering the U.S. onshore oilfield services sector for over 12 years. John graduated with a BS in Finance from Lehigh University and an MBA from Tulane.