FBR Capital Markets: Down cycle will be long and deep

Analysts from FBR Capital Markets are among those with a more bearish view of the current down cycle in international oil and U.S. natural gas, according to a report issued to investors today.
Analysts Robert MacKenzie, Doug Garber and Christopher Breaux say the down cycle will be “u” shaped rather than “v” shaped, meaning it will be long and deep.

“We expect this to be the worst spending downturn since the early 1980s, although not quite as severe.”

One of the differences between then and now is spare capacity of oil, the analysts say. While lower demand creates more spare capacity, non-OPEC supply is in decline. The 1980s saw huge fields discovered in the previous decade come online, including Mexico’s Cantarell, the North Sea and Alaska’s Prudhoe Bay.
Such fields aren’t necessarily waiting in the wings now, so supply will tighten when demand rebounds alongside the economy, even more so with recession-driven spending cutbacks amid oil prices between $40 and $50 a barrel.
The industry’s buzz about offshore Brazil remains robust, but production remains years away. Exxon Mobil chairman and CEO Rex Tillerson told analysts last week that while offshore Brazil is a “significant resource,” calling it another Saudi Arabia as some have done mischaracterizes its nature.
Exxon recently announced a discovery in Brazil’s Santos Basin, and aims to drill a second well. Unlocking Santos resources, estimated by some geologists to hold more than 30 billion barrels of oil, will take technological improvements as well as potential breakthroughs, Tillerson said, reminding analysts that it’s in very deep water, difficult operating environments far from shore and very expensive.
Regarding U.S. natural gas, the FBR analysts joined others who have said the rig count needs to keep falling to balance that market.
Last week Baker Hughes said the nation’s rig count had fallen to 1,170 — most of those onshore gas rigs — from last year’s peak of 2,031. However, natural gas remains at or below $4 per mcf because the cutback in rigs and drilling will take a while to align with fallen demand and the glut of gas produced during last year’s boom in U.S. gas shales.
The FBR analysts say they expect the natural gas rig count to average 882 rigs next year and 782 in 2010 as capital spending falls to rebalance the market. By 2011, they expect the U.S. land rig count to average 1,220, which is only 50 more than recorded last week.
However, conventional rigs are the dropping much faster than those that can drill horizontally. Horizontal capacity means more wells can be drilled from one site, so each drill site can reap more bounty than a conventional vertical well. Horizontal drilling also gave shale production the spark that led to last year’s boom.

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