Is an inflection point at hand in the onshore drilling market?

Nearly two years after operators prophesied a transition to liquids rich portfolios, the oil-directed horizontal rig count topped the gas-directed horizontal rig count during the week ending Jan. 6, 2012.

It marks the first time horizontal oil drilling onshore has exceeded horizontal gas drilling since the glory days of the Austin Chalk in the late 1990s. Raise your hand if you remember UPRC.

Figure 1 For the first time since the 1990s, oil-directed horizontal rig count topped the number of rigs drilling for horizontal gas. Of note is the decline in gas-directed horizontal drilling in the fourth quarter 2011 as dry gas plays such as the Haynesville and Barnett shales experienced activity declines in the wake of low gas prices.

This was a nuanced event. First, it follows the fourth quarter collapse in dry gas horizontal drilling in legacy unconventional plays like the Barnett and Haynesville shales. Secondly, wintry weather dinged rig count last week in the gas-focused Marcellus shale while warmer-than-normal weather in North Dakota allowed horizontal drilling to continue at a feverish pace in the oil-focused Bakken shale.

There is no guarantee those events will continue, so the actual inflection point in the oil/gas horizontal balance may be a temporary nominal phenomenon.

Still, the rise in horizontal oil-directed drilling, coupled with the decline in horizontal gas-directed activity, signals operators are perfecting some new moves on the oil and gas country/western dance floor as formerly gas-focused public independents reinvent themselves as liquids rich companies. Consequently the impending inflection point in the onshore oil/gas horizontal balance is worth noting if only because horizontal drilling previously had been the main proxy for unconventional shale gas.

A quick review of the last half-decade shows operators achieved enormous success in generating production volume growth via horizontal drilling and multistage fracturing in unconventional shale plays in a technological breakthrough that resulted in a rapidly expanding domestic gas supply and falling natural gas prices.

Furthermore, horizontal gas drilling remained active at a higher-than-necessary level in recent years due to artificial stimuli. Operators were compelled to drill natural gas wells to capture acreage in the wake of the profligate 2008 land grab in plays like the Haynesville, where mineral owners happily accepted the three-year lease terms at $25,000 per acre that the industry threw at them.

Those acreage capture programs had run their course by the third quarter 2011, which is evident in the steep drop in gas-directed horizontal drilling in the Figure 1 graph. Additionally hedging played a supporting role in supporting horizontal gas drilling. Like acreage capture programs, hedging at $5+ gas had run its course as well in 2011.

And that brings the onshore market to a time when onshore horizontal oil drilling has taken a step-level change higher just as gas-directed horizontal drilling took a step-level change lower. It also marks the second significant inflection in commodity drilling balance since the onshore oil-directed rig count exceeded the gas-directed rig count in mid-2011 (thanks in part to the incredible ramp in Permian Basin oil drilling).

The other side of the story involves nascent events on the oil-directed portion of the drilling ledger. These include the diffusion of drilling techniques developed in unconventional gas plays over the last half dozen years to tight formation oil plays, a phenomenon reflected in rising rig counts for Mississippi Lime/Cleveland Sands drilling in the Midcontinent and the jump in Niobrara shale drilling in the Rockies.

Perhaps the most interesting part of the inflection is the irony. Onshore horizontal drilling first came to prominence with the Austin Chalk oil boom in the 1990s. However, rising field costs and precipitous decline rates brought an end to the Chalk before the new millennium began. That Chalk legacy lives on in spirit since the Eagle Ford shale is considered a source rock for the oil found in the fracture systems of the Austin Chalk carbonate.

In fact, Eagle Ford drilling is rapidly becoming a proxy for the evolving gas to liquids transition among operators. As the graph in Figure 2 shows, gas-directed horizontal drilling was a primary support for Eagle Ford rig count during the first nine months in 2011. However, Eagle Ford gas-directed rig count fell in the fourth quarter even as oil-directed activity increased. There are multiple factors at work behind the scenes, including rising oil-directed rig counts for Royal Dutch Shell, SM Energy, and Chesapeake Energy to name a few, along with a late-2011 jump in Webb County oil drilling, coupled with incremental increases in oil-directed drilling in a half dozen other Eagle Ford counties.

Figure 2 The graph illustrates oil versus gas-directed horizontal drilling in the Eagle Ford shale. Horizontal oil drilling not only offsets the decline in horizontal gas drilling regionally, it is also growing at a rate that increases overall Eagle Ford rig count. A similar trend is occurring nationwide in the onshore drilling market.

It is also possible some of the shift in the Eagle Ford oil/gas drilling balance may result from a change in classification among rig tracking agencies in October 2011. Lastly, a part of the shift reflects rigs exiting the Barnett and Haynesville for deployment in the Eagle Ford during the final quarter of 2011.

But the result is the same no matter how the numbers get there. Horizontal oil-directed drilling in the Eagle Ford not only offsets the decline in gas-directed horizontal work, it is adding incremental units to regional rig count.

And that Eagle Ford phenomenon reflects the bigger story unfolding nationwide as a vibrant horizontal onshore drilling market grows oilier every week.