National Oilwell Varco Hints at Coming Drilling Crisis

(MoneyWatch) 

• The Company: National Oilwell Varco, a global provider of equipment and components used in oil and gas drilling.
• The Filing: Form 10-Q filed with the SEC on August 8, 2008.
• The Finding: National Oilwell Varco benefited from higher rig construction volumes in the second-quarter ended June 30, with its Rig Technology segment reporting a 49 percent year-on-year increase in operating profit of $506.4 million. Going forward, however, higher material costs, such as steel for piping, could offset improved manufacturing efficiencies.

The Upshot: Rig Technology revenue in the second-quarter increased 36 percent to $1.9 billion, as higher oil and gas prices spurred growing demand for new rigs as well as the equipment, consumables and services needed to reactivate and/or refurbish many older rigs.

Price inflation for steel products -- used in oil and gas wells -- is running about 45 percent this year, fueled by a run-up in prices of its major raw material inputs, coking coal and iron ore. Metallurgical coal is up about 13 percent in price year-on-year to about $104 per metric ton and the price of iron ore scrap has doubled in three years to more than $200 per ton, according to the Energy Information Administration.

The company has generally been successful in mitigating the financial impact of price escalations in all grades of steel by applying surcharges to and adjusting prices on the products it sells. In fact, profit margin grew 230 basis points, as a favorable product mix (higher margin, more-complex directional and extended reach pipe drilling) and higher production volumes offset rising raw material and employee costs.

Efficiency initiatives, such as quick response manufacturing and broader outsourcing, however, will be of little benefit should an expected shortage in supplies of steel piping itself materialize.

The supply of steel pipe is the lowest he's ever seen, said Tudor, Pickering, Holt analyst Jeff Tillery in an interview with The Dallas Morning News. Distributors are keeping less than four months' supply today, compared with six months in 2006.

The Question: Could newer oil and gas plays, such as the Haynesville Shale in Louisiana or the Iara region (off the Brazilian coast), witness drilling delays in 2009?