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BJ Services Sees Additional Decline in U.S. Rig Activity

Are rising energy prices an upbeat sign that demand for oil and natural gas services, from construction of rigging to actual drilling, will pick up in coming months? Unfortunately, the latest earnings report from BJ Services, a leading provider of pressure pumping and other oilfield services to the petroleum industry worldwide, suggests more doom and gloom lies ahead for the oilfield services industry.

BJ Services' pressure pumping services consist of cementing and stimulation services used in the completion of new oil and natural gas wells and in remedial work on existing wells both onshore and offshore. Cementing involves pumping a cement slurry into a well between the casing and the well-bore to isolate fluids that might otherwise damage the casing, or that could migrate to different zones, primarily during the drilling and completion phase of a well and affect productivity. Stimulation services are designed to improve the flow of oil and natural gas from producing formations.

Demand for the company's pressure pumping services is primarily driven by oil and gas drilling activity, which has historically depended on the current and anticipated prices of crude oil and natural gas. During the last 10 years, the lowest annual U.S. rig count averaged 601 in fiscal 1999 and the highest annual U.S. rig count averaged 1,851 in fiscal 2008, according to the 10-Q filing for the March-ending quarter.

Chairman and chief executive Bill Stewart told analysts on the second-quarter earnings call that depressed energy prices, combined with restrictive credit amid the global economic slowdown put a wrench in customers' exploration and capital budgets, with drilling rig activity in the U.S. plummeting from 2,031 rigs at September 12, 2008 to 945 at May 1, 2009. "Our further thoughts [are] that U.S. rig activity will continue to decline in the July quarter to the 700 rig range and maintain that level of activity until natural gas supply and demand are more in balance," said Stewart.

I might add, too, that whether it be shale plays in the U.S. or Artic Circle/Tunda ventures in Russia or other cold-water ports, the prevailing price of natural gas will likely lead to additional project delays or cancellations -- unless BJ Services and other companies can align their cost structure with market conditions in these areas, which is highly unlikely.

Natural gas for June delivery settled at $3.887 per million British thermal units (MMBtu) on the New York Mercantile Exchange, the biggest one-day gain since March 19. Nonetheless, break-even costs to drill in the Barnett Shale, Woodford Shale, and Piceance Basin are approximately $5.12 per MMBtu, $6.93 per MMBtu, and $7.59 per MMBtu, according to a 2008 Credit Suisse energy study.

Given its financial strength, BJ Services is better positioned to ride out a prolonged slump [until mid-2010] in the energy markets than some of its more leveraged peers, such as Basic Energy Services; or, niche oil services companies, such as Bronco Drilling and Pioneer Drilling -- third-party contractors totally dependent on domestic drilling activity.

West Texas Intermediate benchmark crude for June delivery closed on Wednesday at its highest price since mid-November, settling at $56.34 a barrel on the New York Mercantile Exchange. Traders were relieved that Energy Information Administration data released showed that levels of crude in storage did not rise higher than expectations. However, until there's growing evidence to suggest a sustainable increase in demand for oil and natural gas is around the corner, the spike in energy prices could prove to be ephemeral -- similar to bullish talk about better days ahead for oil service companies, including BJ Services.

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