Term contracts are making a comeback for drillers with high-spec rigs. Since the year started, the major drillers have seen operators increasingly use term contracts. As newbuilds roll off original contracts, the 3-year terms that undergirded their creation have been replaced with shorter-term contracts—from as little as 6 months up to 2 years. In an interesting twist, the industry continues to demand new equipment and is willing to support newbuilds with even longer—as much as 5-year—contracts.

 

Last fall drilling contractors reported that operators were buying out term contracts or delaying their drilling programs by idling newbuilds under tolling clauses. The added cash flow from early termination and tolling fees helped the contractors weather the lean times, and the tolling arrangements kept the rigs under the control of the operators who helped build the rigs.

 

There were concerns too many rigs would be pushed into the spot market and drive down day rates. But instead demand grew. Now major drillers see busy fleets, and some high-spec rig fleets are booked through the remainder of 2010. 

According to analysis by The Land Rig Newsletter’s Biweekly Report, operators in 2010 will focus on heavy drilling programs in the shales driven by leasehold commitments, and more asset sales and high hedging levels to backstop cash flow and drilling budgets. Drillers can expect a return to term contracts, especially in the most competitive shales, and more emphasis on liquids-rich plays. As the ongoing shale frenzy contributes to the gas glut, gas prices will slump further, with more big, high-spec rigs finding more work to offset a rig count decline in conventional gas areas. As the gas rig count flattens, the oil rig tally will continue to snatch market share.

What’s driving drilling? The desire to retain hard-fought leasehold positions. During 2007-09, operators assembled more than 10 million acres in just the Haynesville and Marcellus shales. Leases are typically for 3-year terms, suggesting much to be drilled and little time to drill it. Hence, we believe the surge in Louisiana and Pennsylvania drilling still has legs, which could be the death knell for gas prices later this year.