Domestic onshore drilling is growing for fabricators while offshore continues to lag

May 2011 - More than a year after the Deepwater Horizon offshore drilling rig exploded in the Gulf of Mexico, the ramifications of the event continue to affect metal fabricators and OEMs that work in the oil sector.

Many companies that provide products and equipment for use drilling underwater experienced a sharp decline in business after President Obama declared an offshore drilling moratorium last year in the wake of the spill. Conversely, many of those that serve the onshore oil market are experiencing steady business as U.S. oil production focuses on inland opportunities.

The Gulf oil spill is one of the most significant challenges facing the industry, says Jack W. Plunkett, CEO of Plunkett Research Ltd. Despite the end of the offshore drilling moratorium, "it’s very unclear when it’s going to regain significant traction," he says. Because of this, many companies are focusing on domestic onshore drilling, which has created great interest in the segment, "much more than we’ve seen in years," says Plunkett.

In 2010, oil and natural gas together provided more than 60 percent of total U.S. primary energy use, according to the U.S. Department of Energy’s Energy Information Administration. Domestic crude oil production increased by 150,000 barrels per day in 2010 to 5.51 million barrels per day, but the EIA predicts a decline in 2011 by 110,000 barrels per day and in 2012 by an additional 130,000 barrels per day. The forecast includes estimated production declines in the Gulf of Mexico of 240,000 barrels per day in 2011 and 200,000 barrels per day in 2012.

Though oil import totals fell recently, the EIA expects the amount to climb once again. Liquid fuel net imports fell in 2010 "primarily because of the decline in consumption during the recession and rising domestic production," Richard Newell, an EIA administrator, said in a statement to the U.S. House of Representatives’ Committee on Natural Resources. Imports, including both crude oil and refined products, dropped from 57 percent of total U.S. consumption in 2008 to 49 percent in 2010. The EIA forecasts liquid fuel net imports will average 9.7 million barrels per day or 50 percent of total consumption in 2011 and 10 million barrels per day or 52 percent of total consumption in 2012.

Oil spill fallout
When the oil spill occurred in the Gulf of Mexico, "we could see a noticeable decline in business for the Gulf states," says Dave Stanzel, vice president and general manager of construction welding products at Miller Electric Mfg. Co., Appleton, Wis. "But when they put the moratorium on all the Gulf drilling, it was almost like they flipped a switch and turned it off."

The Gulf of Mexico isn’t the only location for offshore drilling, and many other countries are building rigs for use in their waters, says James Kovach, a consultant in offshore and naval shipyards for ESAB Welding & Cutting, Florence, S.C. "Oil companies cannot afford to let their rigs sit idle, so they have no other choice but to move them," he says.

Roughly 90 percent of Delcor USA Inc.’s recent work was in the Gulf of Mexico fabricating subsea modules and more for the oil and gas production industry. After the moratorium, "our sales dropped," says Keith Cole, president of the Houston-based company. "It’s been very difficult. You can’t blame the moratorium for all of it, because a large recession preceded the moratorium, but it was clearly the driving force. This was very much a perfect storm for a lot of companies," he says.

The effects of the offshore drilling moratorium and to a lesser degree the recession forced the company to sell its assets to T-Rex Engineering and Construction L.C., Houston. "At some point you have to go ahead and sell to somebody who has more financial backing," says Cole, noting it was extremely difficult to secure financing from banks or private equity groups during this time.

The offshore drilling moratorium hurt many small and mid-size companies, says Cole. "At the end of the day, the worst part of it was that it was killing lots of small to mid-market companies, the ones that create the most jobs," he says. Larger companies likely did not encounter the same types of difficulties because they are larger and more diversified," he notes.

When business decreased for fabricators that serve the oil industry during the oil spill, some opted to explore other markets. Gilchrist Metal Fabricating Co. Inc. fabricates components for a customer that supports the deep-water drilling industry through buoyancy devices, but that aspect of the business halted after the moratorium on drilling in the Gulf of Mexico, says Jack Gilchrist, president of the Hudson, N.H.-based company. To soften the financial blow, the company looked to other markets, he says.

Moving into new markets can be difficult, however, notes Cole. "It’s hard to pivot your business that quickly, especially in a recession when everybody is hungry and the pricing is at or below break-even margins," he says. "In a good market, you can pivot more easily because there is more work to go around and people fill up their shops pretty quickly."

Onshore growth
Fabricators and OEMs that supply the needs of onshore drilling companies should be seeing an increase in activity, especially in the oil shale areas, says Plunkett. Two oil shale formations, the Eagle Ford shale in Texas and the Bakken shale in North Dakota and Montana, are booming, he says.

The U.S. Geological Survey estimates the Bakken formation alone has 3 billion to 4.3 billion barrels of undiscovered, technically recoverable oil. In 1995, the group estimated the area contained 151 million barrels of oil but revised its assessment in 2008 to reflect a 25 percent increase in the amount of potential oil. The Bakken formation estimate is larger than all other USGS oil assessments in the lower 48 states.

"For some companies, they’ve switched a lot of their interest more to onshore drilling, especially any of the companies that have interests in the Bakken field in the Dakotas and Montana," says Rick Sublette, vice president of operations at Mountain Man Welding and Fabrication Inc., Denver. "It’s just a huge, huge oil play right now."

The use of horizontal drilling is helping to recover more oil from onshore developments, says Sublette. "A lot of companies are starting to do horizontal drilling and getting a lot bigger returns from the wells than they had in the past," he says.

A conventional rig drills a vertical well straight down to access the oil deposits below, says Piotr Galitzine, chairman of TMK IPSCO, Downers Grove, Ill. Horizontal drilling "means going down 5,000 ft. and then doing a right turn," he says. "With the directional rigs, you can keep the same footprint. Leaving your drilling rig in the same place, you can do 12, 24, 36 wells from one location without moving the rig." With a vertical rig, workers must move the entire rig to another location to drill another well.

The directional rigs use a lot more pipe over a year’s time than vertical rigs, says Galitzine, noting the company fabricates multiple types of pipe for use removing hydrocarbons from the ground. Overall, the pipe demand has been good as companies work in the oil shale areas, he says. "Just the Bakken shale alone has become the largest petroleum find in the United States onshore in the last 37, almost 40 years," says Galitzine.

Pipes used in horizontal drilling experience tremendous stress as they move below the surface. "The connections and the pipe itself are in compression because you are pushing. They experience torsion because you are spinning it, and they are bending because you are going through the bend some 5,000 ft. below the surface," says Galitzine.

Declining infrastructure
In addition to increased domestic onshore drilling demand, the industry is seeing growing demand for oil infrastructure replacement, says Plunkett. "The steel infrastructure of the U.S. petroleum industry is in some cases ancient," he says. The pipeline systems and older refineries need modernization and replacement. Some of the steel elements are 40 or 50 years old, and some exist in very corrosive or challenging environments, says Plunkett.

As natural gas or oil moves through a pipeline, it wears on the pipe over time, says Stanzel. "Basically, there is turbulence within that line called cavitation. That cavitation over a period of time can start to also erode the pipe itself," he says. As erosion occurs, the wall of the pipe becomes thinner, which reduces the pressure it can withstand.

There’s also a change occurring in the types of material being used for pipelines, says Stanzel. "There is a notable shift from lower-strength materials to higher-strength materials," he says. Stronger material enables companies to move more product (or material) through a given diameter of pipe.

Indeed, the amount of production occurring in the sector means companies likely will be installing pipelines with larger diameters in addition to replacing older pipes, says Sublette. "I think we are going to see a pretty steady stream of work for several years," he says.

With the opportunities available in the oil sector, "I think there’s reason to be optimistic," says Stanzel. The offshore industry in the United States has been sidetracked at a growing economic cost to businesses. To ensure the domestic oil industry is productive in the future not only for onshore drilling suppliers but also offshore, "fabricators need to be lobbying the government along with the oil and gas industry to get offshore exploration going again," says Plunkett. FFJ

Pain at the pump
As the cost of oil rises, so does demand, which translates to more domestic production. This can mean additional work for the fabricators and OEMs that supply the oil sector. When the price of oil goes above $100 a barrel, "that translates into additional revenue from my standpoint because my customers are buying more product" so they can increase production, says Tra Willbanks, president and CEO of Anchor Fabrication, Fort Worth, Texas.

Anchor is a contract manufacturer with 25 percent to 30 percent of its business in the oil sector. The company fabricates parts for fracture tanks, drilling components and other equipment used at a well site.

With higher oil prices, the return on investment to develop certain oil fields is better because companies can sell the natural resources at increased prices, says Willbanks. "That [puts] some fields in play where otherwise they wouldn’t be, and that means they need more equipment. As a result, we see more work from that."

Rising oil costs can be a double-edged sword for businesses in the sector, however, because fuel costs can eat into margins. "You try and budget and forecast, but it’s up in the air," says Jack Gilchrist, Gilchrist Metal Fabricating Co. Inc. "If you’re a job shop that has long-term repetitive contracts, it’s got to be killing you. If you are a job shop that has different projects every month, it’s pretty much pay as you go."

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