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Precision infusion marks dark season for drilling

In the bitter energy recession of the early 1980s, oil field services companies in Western Canada were falling like flies, and nervous creditors swooped in to repossess idle drilling rigs.

Along came an opportunistic Saskatchewan rig operator named Hank Swartout, who bought these distressed assets from the banks, forming the basis of an energy services colossus called Precision DrillingPD.UN-T.

History is about to repeat itself as the services sector reels from the worst economic conditions in two decades, with drilling activity falling this year by 40 to 50 per cent across North America.

"You've got to go back to the early 1990s, or even the 1980s, to see a downturn like we have now," said John Tasdemir, energy services analyst with Tristone Capital Inc. of Calgary.

That puts this notoriously volatile sector on the edge of another wave of consolidation. Service companies with strong balance sheets, attractive technology, and the best regional plays will pick off weaker players and acquire bargain-basement assets, analysts predict.

Once again, Precision Drilling, now an income trust, is at the centre of the action - but this time, it is one of the walking wounded.

Mr. Swartout is gone and, under his successors, Precision has become a debt-laden giant.

This week, the company was tossed a controversial lifeline by Alberta Investment Management Corp. (AIMCo), in the form of a $380-million capital injection.

In Alberta, battle lines have been drawn between those who view the debt-equity transaction as a blatant bailout by the province's pension fund investor, and those who see it as a sweet investment deal for the province's endowment funds.

It is understandable that other energy services companies are upset, Mr. Tasdemir said. But AIMCo got very good terms for investing in a company with superior assets and a strong potential business, he said, arguing that much of the resulting uproar is being motivated by politics.

The controversy has overshadowed the otherwise bleak state of the sector, as outlined yesterday by Precision president Kevin Neveu in announcing first-quarter earnings that were cut almost in half from a year earlier. He called the winter drilling season the worst in 17 years, and foresaw no major improvement for at least the rest of 2009.

Mr. Neveu pointed to industry statistics as of early April that show U.S. land drilling rig count down about 43 per cent from the same period last year, while Canadian rig count is down about 40 per cent.

 

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Precision controls about 20 per cent of the gas-drilling rig market in Canada.

Mr. Neveu took pains to defend Precision's $2-billion (U.S.) takeover last fall of U.S. drilling company Grey Wolf Inc. as a boost to geographical diversification that puts Precision in relatively good position for the future.

But the disastrous timing and massive debt load of the takeover mean Precision, even with the recent injection, will not be active in the next wave of acquisitions.

"They need to focus on paying down debt, so they are not consolidators," said Todd Garman, oil field services analyst with investment bank Peters & Co. of Calgary.

Instead, he said, the likely buyers will be companies with strong balance sheets, access to capital, and the potential for activity in unconventional resource plays, outside the tapped-out conventional gas fields of Alberta.

Consolidation will come but not right away, Mr. Tasdemir said, because of still-acute debt concerns and the uncertainty of valuing distressed assets in the current climate. "You've got to wait until you think you're at the bottom and the guy you're going to buy is against the ropes."

Services companies follow the energy action, and according to Mr. Garman, that activity will focus on shale-gas regions around the continent. EnCana Corp., for example, has signalled it will push up activity in the Haynesville shale of east Texas and western Louisiana.

The cyclical downturn is combined with a change in the structure of the industry, as gas drilling shifts away from the high-cost, mature Western Canada Sedimentary Basin toward unconventional areas that are intensive in their use of drilling services.

The likely beneficiaries from this shift are those companies with specific drilling skills appropriate for the new fields (including directional drilling) as well as bigger operators with strong balance sheets, such as Ensign Energy Services Inc. and Trican Well Services Ltd.

Mr. Tasdemir also thinks companies such as Calfrac Well Services Ltd., Mullen Group and ShawCor Ltd. may be active in the acquisitions market.

Mr. Garman warned that the structural shift will take time to work out, and low energy prices are not the only factor.

"There is too much equipment in Canada and in the U.S.," he said. The current constraints on access to capital alone, he said, prevent the sector from reaching levels of activity experienced before the meltdown.

 
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