After the 1979-81 oil boom went bust, a lot of U.S. land drillers stacked their iron and headed for bankruptcy hearings. But more than a few drilling contractors, even though decimated by the oil and gas bust, held onto a rig here and a rig there and took the opportunity to pick up discarded iron for pennies on the dollar.

Still others, seeking to compete for work in a badly fractured drilling market, took the time to cobble together newer mud pumps, higher-horsepower rigs and higher-grade drillpipe to create more marketable rig packages.

These weren't merely survivors. These were contractors with a vision-people who understood how cycles work. In short, they understood the inverse of one of Newton's laws of physics-that what comes down will eventually go up again. Today, amid $65 oil and $8-plus gas, that vision has been rewarded.

Two such land drillers that weathered the downturn of the 1980s and capitalized on acquiring old rigs and building new ones before the iron market turned red hot are Union Drilling Inc. (Nasdaq: UDRL) and Pioneer Drilling Co. (Amex: PDC).

In each case, these companies went from a small, regional focus to a broadened geographical footprint across markets where unconventional gas-resource plays are now driving high rig demand and premium dayrates.



Unconventional wisdom

Started in the Appalachian Basin in the late 1950s as a private, family-owned business, now-Fort Worth-based Union Drilling Inc. was acquired in 1997 by a private investor group composed of Somerset Capital Partners and Morgan Stanley Capital Partners. At the time, that group was looking to consolidate the then largely fragmented drilling-rig space in Appalachia.

And consolidate it did. Between 1997 and early 2005, the investor group poured $50 million of private equity into Union, whose Appalachian fleet grew from 12 rigs to around 35. Then in April 2005, it helped Union take another major step, both geographically and in fleet size.

"We completed two major platform acquisitions-the first, a $28.5-million buy of 12 rigs in the Arkoma Basin with an eye towards the emerging Fayetteville shale play in Arkansas; the second, a $20-million, eight-rig purchase in the Barnett shale play near Fort Worth," says Chris Strong, Union president and chief executive officer.

"This, plus the purchase of six more rigs that summer, gave us the needed critical mass to complete a $143-million IPO by December that year, allowing us access to more capital and to achieve a higher valuation than was then available in the private market." The IPO also allowed the private investor group to monetize a portion of its stake in the company.

Besides helping to pay down debt, the proceeds of the IPO allowed the driller to enter contracts to purchase six, 1,500-horsepower, electric rigs from National Oilwell Varco-all of them now working in the Barnett shale.

"Strategically, what we've managed to do is focus our rig fleet-which now totals 72-on the highest-growth areas for land drillers: the unconventional gas-resource plays in Appalachia, and the Fayetteville and Barnett shales," says Strong.

Well suited to those plays, the majority of Union's fleet is configured for both horizontal and underbalanced drilling, technologies that allow high penetration rates in natural gas-bearing formations.

Thus far, Union's strategy has paid off handsomely. Rig utilization has risen from 62% in 2005 to 76% currently. Similarly, revenues have climbed from an average $11,500 per day in 2005 to $14,300 in 2006. Daily margins, meanwhile, have moved up from $3,200 to $5,600. Concurrently, the company's EBITDA (earnings before interest, taxes, depreciation and amortization) has jumped from $27 million to $81 million.

Is this growth sustainable? The likely answer: yes. "We've seen the rig count for gas drilling in the U.S. double in the past few years-with very little increase in production, if any," observes Strong. "This is the result of declining average-well productivity as well as increasing decline rates in output.

"So the industry may well find that it's going to need to add more drilling rigs simply to sustain, let alone grow, production," he stresses. "Given this, my guess is that the perceived overhang of current rig supply may in fact be absorbed within the next year or so."

This doesn't necessarily mean Union is in a hurry to put orders in for new rigs. Quite the contrary, it is choosing in these times of frothy dayrates and plentiful rig supply to be patient. As for purchasing used rigs, the mantra for Strong is also "wait and see" until more price rationality returns to the older-equipment end of the market.

What does make sense, however, is looking at adding complementary services in the markets that Union already serves, he says. "I'd be interested, for instance, in adding more top drives to our drilling fleet rather than have our customers rent them out separately. That sort of thing tightens up the rig time on a well for an operator while at the same time providing us some upside and competitive advantage as a complete-solutions drilling company."

Strong notes that top drives are generally preferred by producers for the directional or horizontal drilling that abounds in unconventional gas plays such as the Barnett or Fayetteville shales because they allow an operator to more precisely steer a drillbit through the horizontal section of a pay zone.

"Besides the widespread use of horizontal drilling in the Barnett and Fayetteville plays, we're also starting to see the increased application of this technology in the Appalachian Basin where we have 30 rigs running," he adds. "Very simply, producers are beginning to realize more and more that this technology allows them to book larger reserves per well while recovering those reserves more rapidly versus drilling a well vertically."

Should Union decide to add more services to its drilling-fleet, it has plenty of financial elbow room. "We have a $100-million revolving line of credit with PNC Business Credit, of which only $35 million has been drawn down," Strong says. "Also, we're cash-flowing very nicely right now, as our EBITDA suggests."

Has the oil-service industry learned any lessons from past cycles? "Yes, I think there's a lot of discipline on the part of drillers right now, due in no small part to the fact that there's a perceived overhang of rigs in the market," says Strong.

"That said, given the gas-decline rates in the U.S. that I've already mentioned, we're clearly going to need more rigs going forward-and that's just to produce the same amount of gas that we're producing today."



Pioneering spirit

Begun in 1968 and once known as South Texas Drilling Co., San Antonio-based Pioneer Drilling Co. managed to weather the downturn of the early 1980s, the days of stacked iron and a time when banks owned more rigs than drillers did.

"When I joined South Texas Drilling in 1995, we had fewer than four rigs in operation, an interest in some 20 stripper wells in central Texas and a scattered focus on other types of operations," recalls William Stacy Locke, Pioneer president and chief executive officer. "Shortly thereafter, we made the strategic decision to focus on our core competency-land drilling in South Texas and the upper Texas Gulf Coast."

With this in mind and a $2-million loan from an asset-based lender, the company began modernizing and upgrading its four-rig fleet with higher-horsepower mud pumps and higher-quality drillpipe to give it a better shot at marketing its rigs.

But this was only part of the company's strategy. The other part was using that small funding to start acquiring rigs and upgrading them as well.

The first acquisition was in June 1997, with the purchase of a small, two-rig, Corpus Christi drilling company for about $1.5 million. But with subsequent private-equity infusions from the Temple Foundation in East Texas and the Wedge Group in Houston, plus debt financing from various lenders, South Texas Drilling grew like Topsy from then on.

"Overall, we acquired a total of 10 land-drilling companies, with an aggregate fleet of 35 rigs, at an average cost of $2.5 million per rig, plus another four rigs in separate transactions that averaged $2.4 million each," says Locke. "In addition, during those times when the acquisitions market grew too expensive, we added 26 premium, new-build, primarily electric, 1,000- to 1,500-horsepower rigs at an average cost of $8.2 million per rig.

"Today, if you look at the blended cost of our 66-rig fleet (the company sold two of its purchased rigs and retired another), it amounts to about $5 million per rig."

Opportunistic buying, to be sure. But more importantly, the formerly South Texas-focused company-which changed its name to Pioneer Drilling Co. in 2001-managed in the process to broaden its geographical footprint and customer base.

Besides the 17 rigs it now operates in South Texas, it has 20 working in East Texas; 10, in North Texas; 13, in the Rockies; and the balance, in Oklahoma.

With this expansion, plus the vastly improved market for gas drilling in the U.S., Pioneer has seen its fortunes rise in tandem. Its rig utilization, for instance, has been running at 95% for the past three fiscal years; comparatively, it was 83% for the three preceding years.

In addition, margins for its land-rig fleet have risen steadily. For fiscal 2003, they averaged about $1,500 per day; in fiscal 2005, they more than doubled, to around $3,400; then in fiscal 2007, which ended last March 31, they nearly tripled, to about $9,200.

The impact on top-line and bottom-line performance? For fiscal 2007, Pioneer's revenues increased 46%, to $416.2 million, versus $284.1 million the prior year. Meanwhile, net income grew 66%, to $84.2 million or $1.68 per diluted share, compared with fiscal 2006 net earnings of $50.6 million or $1.06 per diluted share. At the same time, 2007 EBITDA shot up 62%, to around $180 million, from $111 million the prior year.

"Being able to market high-quality rigs, plus our ability during slow periods to do turnkey jobs in select markets, has certainly contributed to this financial performance-but it's not the only factor," stresses Locke.

"We manage for the long term, and in a rising dayrate environment, this has meant being willing to lock in dayrates on long-term contracts that have secured for us a certain return-at least 15%-on our invested capital," he explains.

"In some cases, this has translated into giving up a little money on the upside as dayrates rose beyond our contracted rates. But by locking in dayrates for two or three years out, we believe we've managed to forge tight relationships with premium customers that are going to remain solid for decades to come."

This strategy appears to be working for the driller. Today, it has eight rigs working for one major independent and six rigs each working for two other prominent producers.

Consistent with its growth pattern since 1997, Pioneer is now looking at entering drilling pastures abroad. "We don't want to become too dependent on any one market," says Locke. "For this reason, we've purchased one additional 1,500-horsepower electric rig and have secured two other similar rigs for potential delivery to international markets that will likely work for foreign-based oil companies."

Meanwhile, at home, Pioneer is considering building some new, fit-for-purpose drilling rigs to put to work for some of the bigger independents. This includes adding top drives to its fleet to improve drilling efficiency as the industry focuses more on directional and horizontal wells in unconventional gas-resource plays. Concurrently, it's also considering entering other businesses closely tied to land drilling such as well servicing.

All this expansion shouldn't present any financial strain for the driller. As of March 31, it was debt-free, had $85 million in cash, an available $20-million credit facility, and about $124 million in positive working capital.

Still, if past is prologue, isn't there a danger of overbuilding in the land-drilling market? "In the near term, no," says Locke. "Operators are going to need more fit-for-purpose rigs to improve their economics in repeatable, gas-resource plays such as those in the Uinta Basin, the Piceance Basin and the Barnett shale, where the same well plan is used over and over.

"And, as producers continue to high-grade their rigs to fit-for-purpose drilling, that's going to cause some of the older-style rigs to become obsolete which should, in turn, reduce rig supply. Thus, during the next few years, any rigs built will be necessary."