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Stock Strategist Industry Reports

The Bifurcation of the Land Rig Fleet Is Here

The big three land drillers are set to profit from gains in rig efficiency.

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Land drilling is highly cyclical, fragmented, and extremely competitive, historically challenged by chronic pricing pressure. As a result, drillers have found it difficult to consistently generate economic returns over the course of a cycle. However, in recent years the market leaders,  Helmerich & Payne (HP),  Nabors Industries (NBR), and  Patterson-UTI Energy (PTEN), have carved out a growing, profitable niche by providing higher-horsepower AC-powered rigs to serve growing demand for unconventional production and horizontal drilling. These drillers, which control only about one third of the overall land-rig market, make up about half of the unconventional shale-drilling market and about 85% of the industry's AC-drive rig fleet. As the industry continues to upgrade its fleet with more powerful and more efficient rigs, we anticipate that these premium-rig providers will benefit disproportionately over the medium term as mechanical and silicon-controlled rectifier, or SCR, rigs are gradually rendered obsolete.

Land Drilling Is a Challenging, No-Moat Industry
Land drilling is a commodity industry in which competitors have historically demonstrated little differentiation and customers have therefore had low switching costs. Contract land drillers provide rigs, equipment, and crew to drill wells for a contracted period or on a footage-per-well basis. Drilling rigs are not proprietary, assembled with parts from third-party suppliers, though they can be customized with technical specifications and modifications to suit particular well conditions. Contracts contain agreed-on day rates, and terms can range from six months to seven years depending on rig supply and demand. Contracts are often awarded on a bid basis, based often on price as well as the availability and condition of equipment. Customer relationships and differentiation on rig efficiency, quality of service, and safety track records, can help secure contracts and renewals, but historically, drillers have had little pricing power unless rigs are in short supply. Rigs that are not contracted out are available on a spot basis for short-term work or "stacked" (idled) if there is not sufficient demand. New rig orders are often supported by multiyear contracts, which protect contractors from capital outlay risk, as newbuilds with contracted terms of three years or longer can usually recoup most if not all of the rig's capital investment over the life of the contract. When rig demand is high, competitors also often build on speculation as well, owing to the long lead time (nine months to a year) of key rig components.

Connie Hsu does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.