The U.S. at present has some 1,700 land rigs, and rig contractors could add up to 191 new and refurbished rigs to the domestic fleet during the next 12 months, according to estimates by Waqar Syed, an analyst with Petrie Parkman & Co. This substantial addition of nearly 200 rigs still falls short of demand, however. Operators would like to have an additional 250 rigs a year added to the U.S. land fleet. Most of today's interest is in 1,000- to 1,500-horsepower rigs, which typically drill to depths between 8,000 and 15,000 feet. Dayrates for these rigs are climbing along with the strong demand. Newly built 1,000-horsepower rigs are commanding dayrates of $18,000 to $18,500, generating daily margins in the $10,000 range. Major drilling contractors are currently reporting average margins in the range of $6,200 to $8,200 per rig-day, and Syed forecasts average margins will hit $10,000 per rig-day next year. That level is what contractors often cite as meeting replacement-cost economics for a 1,000-horsepower rig. (Dayrates for the larger 2,000- to 3,000-horsepower rigs still languish well below replacement costs.) Land rigs in the 1,000-horsepower category typically cost $10 million to build and take about eight months from order to delivery. Currently, U.S. manufacturers can supply 10 new rigs per month and Chinese manufacturers can contribute another five per month, for a total of 180 new-builds a year. Compared with recent trends, that's very good news, although during the rig-building frenzy in the 1980s, peak manufacturing capacity was 240 rigs a month, or an incredible 2,880 units per year. To address the surging demand, rig manufacturers are rapidly adding capacity: just a few months ago, Petrie Parkman estimated that about 130 rigs were being built or refurbished annually. Helmerich & Payne, Nabors and National Oilwell Varco each have major new-build programs under way, and other companies such as M.D. Cowan Inc. and Shramm Inc. will add manufacturing capability. There are several issues in the manufacturing chain that constrain the rate of growth at present. Swivels, pulleys and bearings are in short supply, and companies can wait a year for delivery on those parts. Drill-pipe orders take nine months to fill, and requests for blowout preventors take between six and nine months. Still, these are likely short-term concerns, as the U.S. and Chinese manufacturers will work hard to fix the problems to ensure they can meet demand. "We believe that, over time, the rig-building industry will increase its capacity such that incremental supply and demand will move to equilibrium, perhaps as early as late 2006 or early 2007," says Syed. Supply may even begin to exceed demand by late 2007, if the pace of rigbuilding continues. Nonetheless, contractors are not acting impetuously, as most new-builds or refurbishing projects are commencing only if a contract is in hand or a particular job is in sight. Petrie Parkman calculated that a rig upgraded for a cost of $6 million needs to fetch dayrates of nearly $14,000 for three years to generate a 15% to 20% internal rate of return. A new-build 1,000-horsepower rig needs an $18,000 dayrate for the same returns. The stocks of land drillers have delivered sterling performances this year, generating returns of as much as 67%. Investors should not be over-enthusiastic, however. Although the fundamentals are very attractive in the land-drilling business, and dayrates are continuing to increase, the stocks of the land drillers already reflect the replacement values of the fleet and the leading-edge dayrates. Near-term upside is limited. "We believe these stocks may move sideways here for some time before they begin another round of appreciation," Syed says. Eventually, when investors believe in the longevity of the up-cycle, and when they see land drillers' earnings continue to increase even at margins of $10,000 per day, the stocks should regain their luster. Offshore drillers may offer more near-term potential for stock-price growth, as the barriers to adding new capacity are higher. Jack-ups cost $150 million and take two years to build; semisubmersibles and drillships cost up to $600 million and require four years to construct. Petrie Parkman forecasts a stock price upside of between 11% and 12% above current prices for land drillers, versus 18% and 23% for some offshore drillers.