Last year we heralded the rise of the independent drilling contractor, noting that 54 percent of active rigs in the Permian Basin were drilled by independent contractors outside of the eight biggest companies. At that time crude was selling for $101.92 a barrel and the boom was in full swing, creating the optimal environment for enterprising independents to make their name. Drilling companies multiplied like rabbits as the market struggled to meet a tidal wave of demand for new wells.
A little more than a year later, those same independent contractors face a market that’s incredibly risk averse. While interest rates have remained relatively low, commodity prices have fallen drastically and squeezed profit margins for operators. As a result, smaller contractors are getting fewer and fewer calls to go out and drill, forcing them to innovate and adapt.
In August of 2014 Octane Energy’s Jared Blong was looking to acquire a few rigs and get into the drilling business. Octane was strictly a consulting operation at the time, with experts who helped clients maximize efficiency all the way from exploration to completion, but with the market hot Blong and his partner planned to expand into drilling themselves. Then in September a downward trend began and on Thanksgiving day OPEC gave the now-infamous announcement that they wouldn’t be curtailing production, and oil prices took a dive. “We woke up that morning very glad that we hadn’t just bought some expensive drilling rigs,” said Blong.
Instead Octane retained its original business model, helping shepherd capital and ensuring that drilling is done as efficiently as possible. “Strangely, this has been a great time for us. With $40 oil, making good use of your capital is even more important that it was just a few years ago,” Blong explained.
During the boom, drillers invested heavily in flashy new rigs and relied on technology and high prices to bail them out when they came up with less-than-optimal leases or poorly executed wells. Now the conditions are separating the sheep from the goats. At last year’s prices you could drill a $10 million horizontal well and be assured a decent return but that’s no longer the case. Blong explains, “As commodity prices drop those wells they drilled 12 months ago aren’t profitable anymore. You can have the rock, the newest tech, and still not make money.” Blong and his team have carved their niche by helping drillers succeed under these more challenging circumstances.
Octane decided not to expand into drilling after the OPEC announcement and experienced growth as a result, even as things slowed down. Existing drilling contractors had to find crafty ways to stay busy as well.
Some contractors were forced to pivot and started hunting down business drilling things besides wells. With frac’ing now common in the Permian Basin, there’s a demand for saltwater disposal wells to jettison the leftover produced water when a well is completed. Some drilling contractors are flexible enough to move into that market in thin times, but most agree it’s not a position in which they’d prefer to be.
Other contractors have embraced construction drilling to keep things going. Bamon Morris leads Phoenix Drilling in Hobbs, a drilling contractor specializing in conductors and ratholes. He explained that originally almost all of their business was on the drilling side, but occasionally operators would contract them to drill for a construction project on the production end. “Now we’re pushing much harder on that part of the market. With a lot of companies we have an advantage because were already on their approved vendor list,” said Morris.
Once new leases start popping up again, Phoenix will get back to setting conductor pipes, but for now they working away laying the foundations for new gas plants and refineries in southeastern New Mexico.
An odd legal parameter is also generating business for independent contractors. Leases often contain a clause that prevents operators from stopping production on a property for a given period of time. This keeps big companies with lots of resources from buying up leases before they’re prepared to drill on them, but provisions like these are tricky to handle when commodity prices fall and operators have to choose new well locations more carefully. If they don’t uphold the conditions of the lease they might be forced to give it up to another operator or renegotiate the terms under less favorable conditions, but taking on a large new drilling project with low oil prices is risky.
In such a situation it might be cheaper for an operator to drill a shallow vertical well to retain the lease, rather than renegotiate with the mineral owners or risk losing the acreage altogether. These operators will then ask a small contractor to come in and drill a vertical well to maintain the conditions of their lease so that they can resume production on it when the market picks back up.
Although these shallow verticals wouldn’t necessarily be given the go-ahead in a surging market, small contractors can often drill them quickly and cheaply and end up making money for themselves, the operator, and the mineral owners as well. In this way, independent contractors help the industry use capital efficiently in times when big investments aren’t being made as often.
Some operators are seizing the opportunity to get wells drilled at low service costs, and that keeps small contractors working as well. One contractor said, “I’ve drilled for some operators that will drill now because the price of services are so low. It’s always a pricing issue. If commodity prices rise again then so do services.” Those with the financial flexibility to drill now are doing so in hopes that when oil prices rise again they’ll have saved money by drilling in a lower cost climate.
Another bizarre trend is causing a small spike in the number of wells drilled by small contractors in the final quarter of this year. Usually, the fourth quarter is a slow time for contractors because businesses are coming to the end of their budget for the year and don’t have the capital to start new projects. However, because of the turbulence in the market this year a lot of operators are sitting on a budget surplus, and want to make sure and spend it before year-end evaluations. Oddly enough, wells are being financed now because of the poor state of the market earlier this year.
With slimmer margins for error than just a year ago, independent contractors have to rely on the experience of their staff to drill wells efficiently when they do get the opportunity. Patriot Drilling in Midland has built a distinguished resume drilling short horizontal wells and owes most of its success to the skill of its crews. Patriot doesn’t use AC rigs and while that prevents them from taking on huge horizontal projects it helps them keep costs low. Vice President Leroy Peterson summarized by saying, “Of all the resources you can throw at a well, your human resources are the most important. We’ve been able to compete against the big rigs and win because we’re cost effective and our people know how to get it done.”
Oil companies that emphasize local talent and celebrate the crews that execute their wells are not unusual in the Permian Basin, though they might be rare outside of it. Year-to-date statistics show that the majority of drilling contractors working here are still independent companies outside of the largest eight, and that 34 percent of all operators drilling or permitting here are headquartered locally—marking the largest such percentage within any basin in the world.
Drilling contractors are confident that this unique characteristic gives the region an advantage. A larger number of working independents allows capital in the Permian Basin to be more nimble and as a result the industry itself is more responsive to change. “I’m still confident in the resiliency of our industry,” said Peterson. “When conditions change you figure out others ways to operate; it just takes an adjustment.”
Peterson has seen similar changes before and maintains that there’s no better place to be an independent. “I wouldn’t want to be anywhere else, whether I’m an operator or a contractor. There’s no better place to be than right here.”
Small drilling contractors thrived here during the horizontal drilling renaissance when the credit was cheap and the opportunities were plentiful, but even now under much different conditions the Basin is still the best place for indies and looks to be that way for some time.