Nice work, guys, but take a break. That appears to be the advice offered to companies who are building new oil country tubular goods (OCTG) manufacturing facilities or those still mulling whether to add new capacity.
OCTG projects that have come online recently or are in the works will provide more than enough supply to meet even current strong demand, Paul Vivian, principal of tubular market research firm Preston Publishing Co., Ballwin, Mo., said. "Stop building. If you havent announced, that means dont announce . . . were not overbuilt. Were not underbuilt. Were in a good range. But its time to stop."
Vivian isnt concerned so much about the high end of the OCTG market as he is with the lower, carbon commodity end. "We have way too much carbon," he said.
Part of the problem with new capacity might be that some old capacity that was expected to fold following the 2008-09 financial crisis didnt, Vivian said, noting that while the drill rig count fell dramatically in the wake of the crisis it also spiked again with equal drama. "People that were thinking, Maybe we ought to mothball this thing, started to get orders, and the orders came on strong."
If the rig count were to retreat from above 1,800 rigs to around 1,500, a normal correction situation, current OCTG capacity utilization might fall to the 60-percent range, something that would be dangerous but not deadly, he said, adding that he didnt expect anything like the hyperventilated crisis of late 2008 and early 2009 when import ordersmostly from Chinacontinued to enter the market six months after drilling activity had collapsed. That traumatic event for the industry saw capacity utilization fall to around 25 percent, Vivian said. But he speculated that if it hadnt been for the import overhang, capacity utilization might have fallen only to around 40 percent.
Eric Klenz, KeyBanc Capital Markets Inc. director and metals and mining practice leader, agreed, especially given that OCTG capacity isnt being added just in the United States but around the world. "I suspect that the projects that have been announced are sufficient," he said. "At this point, its hard to say if anybody could justify a new project. Im leaning toward no. "
Klenz thinks the energy market is still hot, especially with explosive growth on shale and other unconventional plays for both oil and natural gas. As he sees it, mills are doing a good job supplying the market and a "Black Swan event" like the rig count crash in late 2008 and early 2009 isnt in the cards anytime soon.
The oil and gas market, which is notoriously cyclical, will remain so, he acknowledged, but that cyclicality likely will make for a bumpier ride for those making or selling commodity grades of OCTG than for those producing or peddling premium grades required in complex shale or offshore projects.
Given that only small cyclical changes are expected, the outlook for the sector remains very positive, something that has caught the attention of players with deep pockets who might want to gain more exposure to oil and gas, Klenz said. "I think you are seeing more M&A around energy, both production and distribution, and I think thats going to continue."
The potential for mergers and acquisitions is strongest in the distribution market, which is less consolidated than the steel production side and therefore has a bigger universe of buyers, particularly for companies that have established a profitable niche for themselves, Klenz said.
But steel could continue to see M&A activity as companies such as Lakeside Steel Inc., Welland, Ontario, acquire complementary pieces of steel assets to fit into their growth plans. The steel pipe and tube maker, which is building new pipe mill and heat-treatment facilities in Thomasville, Ala., in late May acquired a threading and upsetting facility in Corpus Christi, Texas, to better serve its U.S. customers.
Morningstar Inc. equity analyst Mark Hanson keeps a closer eye on energy companies than he does steelmakers. But that also means he keeps a closer eye on the rig count and drilling trends than some steel analysts might. Hanson is bullish when it comes to drilling activity. "I think there are enough factors right now that you are going to see a sustained level of drilling activity for at least the next five years," he said.
Thats thanks in no small part to high oil prices, which have seen a resurgence in interest in mature plays such as the Permian Basin in west Texas and eastern New Mexico, as well as a rush of activity on oilier shale plays, Hanson said. Natural gas might have kicked off the unconventional rush in the early 2000s that gained steam from 2005 to 2007, but its oil thats driving the unconventional bus now, he said.
With natural gas prices low, the gas rig count is being bolstered largely by drillers seeking to hold leases on land acquired in a frenzied land grab in late 2008, Hanson said. After the financial crisis, natural gas drillers found themselves in a bind as gas prices collapsed, and many turned to overseas interests with deep pocketsmining companies like Australias BHP Billiton or state-owned energy firms like Chinas CNOOC Ltd.to fill the cash void.
In some cases, that money wanted exposure to the U.S. energy market as well as know-how from U.S. shale drillers that could be transferred to potential shale plays in areas like China and eastern Europe, Hanson said. The result: natural gas drillers can now afford to take the long view and theyve got someone to share the short-term cost hit on drilling what might be unprofitable wells at current natural gas prices in order to hold leases, he said. A parcel of land might require that one well be drilled to hold the lease, Hanson explained, but another seven rigs could be drilled later when gas prices recover. And for joint-venture partners, the investment might have already paid for itself in terms of knowledge transfer even on money-losing wells.
But he cautioned that the natural gas rig count could temporarily decline as lease-holding drilling winds down. But the very same companies known for drilling for natural gas at a fast clip have largely switched to drilling for more-profitable oil or natural gas liquids (NGLs), Hanson said. And the same issue of holding leases now applies in that sector, too. "The exact same thing plays out. Im going to keep my foot on the gas to make sure I hold that acreage. But now its just on oilier properties," he said.
Hanson acknowledged that such a rush of production could see a surge in oil or NGL supplies, but the same problems that hit the natural gas market would be unlikely to play out in oil because the commodity is more fungible and globally traded than natural gas.
Natural gas, in contrast, faces export restrictions, not only in terms of policy but also in terms of facilities equipped to export liquefied natural gas, Hanson said. The same restrictions dont apply to oil exports, he said. "(With oil) youre linked to a global market, so youre not going to have a repeat of 08 and people say, Oh, shoot, we just found 100 years (worth) of nat gas. We cant legally export it. There arent facilities to move it out of the country. Its stranded."
But Hanson also is bullish on natural gas over the long term. New demand might come from natural gas vehicles, assuming the infrastructure were in place and the government, commercial truckers or big shipping companies switched to using natural gas-powered vehicles, he said.
Besides, with natural gas prices low, the gas rig count should decline as fewer wells are drilled to hold leases and little market incentive exists to drill new wells, Hanson said. That should finally slow the build in natural gas supplies. And if demandfrom a source such as natural gas-powered vehicleswere to kick in, drilling activity in natural gas could pick up again, he added.
Still, Hanson cautioned that the outlook wasnt exactly for blue skies as far as the eye can see. While high oil prices generally are good for drilling, a spike in prices to, say, $150 per barrel due to further tensions in the Middle East could cause demand destruction and throw a wrench in his forecasts. Or in contrast, if the United States or another major economy slip into recession, oil prices might crater, he said. "But there is case to be made for $80 (per barrel) oil going forward. And at $80 (per barrel), most of the plays in the lower 48 (states) make pretty good money."