Another Way to Play the Shales

The onshore North American market is in the process of shifting toward liquids-rich production, given the premium oil currently enjoys to natural gas. Earlier this year, the number of active oil rigs in the U.S. finally overtook the number of active gas rigs, marking the first time going back as far back as 2000. Since these liquids-rich plays are most often unlocked through horizontal drilling, one of the most direct ways to take advantage of the current shift to liquids is to invest in a contract drilling company such as Precision Drilling (NYSE: PDS  ) .

Here's how Precision compares with some of its peers.

Company

Market Cap

Net Debt

Price-to-OCF

Forward P/E

Pioneer Drilling (AMEX: PDC  ) $603 million $221 million 5.3 13.8
Parker Drilling (NYSE: PKD  ) $868 million $384 million 7.9 9.9
Precision Drilling $3.1 billion $732 million 7.9 7.7
Patterson-UTI Energy (Nasdaq: PTEN  ) $3.2 billion $400 million 4.0 7.6

Source: S&P Capital IQ.

The multiples on the drillers are all fairly low, but contract drilling is a cyclical business. It's important to know that the company can ensure its success over entire business cycles.

Horizontal focus
Precision currently has 238 active rigs, making it one of the most active drillers in North America. Of those 238 rigs, more than 200 are drilling horizontally. Rigs that can drill horizontally have been in high demand, and just about every single one of them is being used. Exploration and production companies wanting to add additional horizontal rigs have therefore had to contract new builds.

It seems like a no-brainer that horizontal drilling would be up, with so much activity across many of the emerging shale plays. However, almost 85% of the company's active rigs are pursuing horizontal drilling, compared with about 65% of active rigs for the industry. Precision has obviously made horizontal drilling an area of focus and has made the shift faster than its average peer has. The situation should further improve in 2011, with more than 40 new builds targeting unconventional drilling.

Addressing the risks
Companies that provide contract drilling services can be deeply affected by the capital-spending whims of oil and gas explorers and producers. Precision has a few explanations for why these risks are mitigated:

  • Oil vs. gas: Compared with the last peak in 2008, there are many more land rigs today drilling for oil. It would take many, many more wells in liquids-rich areas for the U.S. to become a net importer of oil. Even if that were to happen, oil is a global commodity, and it can be transported much more easily than natural gas, so a repeat of the shale gas boom (and the corresponding supply glut) is less likely to happen in oil.
  • Long-term contracts: New builds are being built into long-term contracts that last anywhere from two to five years. What's more, these long-term rigs are being awarded to well-capitalized large-cap companies, not micro caps that lack the visibility to enter into such contracts. As long as new builds continue to demand long-term contracts immediately, rig usage should become a bit more steady.

Foolish bottom line
Precision is a major player in the North American energy scene, with more than 300 total drilling rigs at its disposal. Moreover, a much higher percentage of its active rigs are drilling horizontally when compared with the industry average. Investors who would rather make a broad bet on horizontal drilling rather than make specific bets on explorers and producers might want to seek out a contract driller such as Precision.

Paul Chi is an analyst on the Fool's Alpha and Duke Street services. You can follow him on Twitter to stay up to date on his latest market commentary. Paul and Matt Argersinger co-manage the Street Fighter portfolio, where they look for cheap, unloved stocks with home-run potential. Motley Fool newsletter services have recommended buying shares of Precision Drilling. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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