Union Drilling (UDRL)

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Rashad Badr

Union Drilling (NYSE: UDRL) provides contract drilling services and equipment (including drilling rigs and their crew) to land-based, natural gas producers in the United States.^[1] In 2007, 84% of Union Drilling's $289 million revenue came from "daywork" contracts, where Union Drilling was paid for each day their rigs and crews were used by respective operators.^[2] However, plummeting oil prices reduce demand for drilling services, in turn lowering the number of daywork contracts Union Drilling works on.^[3] Union Drilling distinguishes itself from other drilling contractors with the ability to drill horizontally and and in difficult, mountainous terrain, such as in key rigging markets like Appalachia. ^[4]

Starting in April of 2005, Union Drilling began expanding its national presence by acquiring Thornton Drilling Company which operated in the Arkoma Basin of Oklahoma and Arkansas. Additionally, Union Drilling acquired SPA Drilling L.P. which operated eight rigs, five of which were in the Barnett Shale formation in Northern Texas, the largest natural gas field in Texas.^[1]

As a result of these acquisitions, Union Drilling saw a 12% increase in revenue to $289 million in 2007 from $256 million in 2006.^[5] Operating expenses, however, increased by 11%, or $16.8 million in FY 2007 and by 52%, or $53 million in FY 2006 as a result of the costs of integrating these acquisitions.^[5] Union Drilling's business performance subsequently saw a 7% decrease in net income in FY 2007, from $32 million to $30 million.^[6] Union Drilling's performance is also impacted by challenges that arise from changing levels of American development and exploration in onshore natural gas, costly repairs to fix aging equipment, as well as seasonal impediments, such as snow and ice, that limit operations during colder parts of the year.

Business Overview

Union Drilling owns and operates 71 oil rigs capable of operating in unconventional, mostly mountainous, natural gas producing areas.^[1] Of these 71 rigs, 50 are equipped for drilling horizontal wells and 44 are rigged to provide underbalanced drilling, allowing for higher penetration rates through harder substances than traditional drilling operations. These capabilities distinguish Union Drilling from other contract drilling services. ^[1]

Union Drilling operates in three markets: the Appalachian Basin, the Arkoma Basin, and Northern Texas.^[7] Starting in 2005, Union Drilling began expanding its national presence through the acquisition of Thornton Drilling Company and SPA Drilling L.P. ^[1] In 2007, Union drilled wells for 114 different customers, a decrease from past years indicating Union Drilling's concentration on fewer customers. Union Drilling's top 20 customers accounted for 76% of total revenue in FY 2007.^[8]

Business Financials

In FY 2007, Union Drilling increased revenue by 12% to $289 million from $235 million the previous year.^[5] Revenue grew by approximately 81%, or $115 million, in FY 2006 from FY 2005.^[5] Increases in revenue are a direct result of Union Drilling's acquisition of Thornton Drilling Company and SPA Drilling, L.P., as well as the addition of new rigs to Union Drilling's Texas operations^[5] Operating expenses, however, increased by 11%, or $16.8 million in FY 2007 and by 52%, or $53 million in FY 2006 as a result of the costs of integrating these acquisitions.^[5] Net income also decreased by 7% in FY 2007, from $32 million to $30 million.^[6]

Business Segments

All of Union Drilling's revenue comes from its land drilling services, with segments only being distinguished by theater of operation. Union Drilling's areas of operation are in the Appalachian Basin, stretching from New York to Tennessee; the Arkoma Basin located in eastern Oklahoma and Arkansas; and the Fort Worth Basin in northern Texas.^[1]

• Appalachian Basin- The Appalachian Basin is one of North America's largest hydrocarbon producing regions, spanning over 70,000 square miles and covering seven states. There have been increased acquisitions and divestitures of oil and gas properties in the Appalachian Basin in the last three years which has increased business in that market. Union Drilling owns and operates 32 drilling rigs in the Appalachian Basin.^[10]
• Arkoma Basin- The Arkoma Basin is located in eastern Oklahoma and Arkansas and spans an area of approximately 34,000 square miles. The acquisition of Thornton Drilling in April 2005 led to Union Drilling's presence in the region, especially its horizontal drilling capability. Union Drilling markets 19 rigs in this area.^[10]
• Northern Texas- Union Drilling's operations in the Barnett Shale formation near Fort Worth fall into the largest natural gas field in Texas. Union owns and markets 20 drilling rigs in this area.^[10]

The expansion of Union Drilling into the Arkoma Basin and Northern Texas led to an increase in its number of customers from 112 to 148 in FY 2006; however, this number fell back to 114 in FY 2007 as Union Drilling concentrated its drilling activities on fewer customers.^[8]

Trends and Forces

Volatility of U.S. Onshore Natural Gas Exploration Results in Unstable Profitability

Union Drilling's business and operations are dependent upon the level of American development and exploration in onshore natural gas.^[12] In 2001 and 2002, there was an economic downturn in the onshore contract drilling industry resulting in losses in operating results as well as profitability across the entire industry. During this time, natural gas production decreased by over 24%.^[13] Conversely, as of 2005, demand for drilling services has been strong, as noted by an increase in customers^[12] as well as a 70% increase in the price of drilling products and services.^[14]

Politically speaking, the outcome of the 2008 presidential elections and the promotion of political and economic incentives for the development of alternate energy sources challenges the onshore contract drilling industry by diverting resources and exploration efforts towards other energy outlets.^[15]. On November 10, 2008, President-elect Barack Obama announced measures to limit gas drilling in the United States, reversing executive orders supportive of the drilling industry signed by President Bush. ^[16]

Aging Equipment Requires Increased Capital to Upgrade and Repair Rigs

Union Drilling's rig fleet is outdated with many rigs nearing their expiration. Union's rigs were built between the years of 1976 and 1982, the last period of substantial rig construction. Aging equipment requires upgrades and refurbishment, normally taking 60-90 days of work to complete at an excess cost of $200,000. If left unchecked, an idled rig would require between $1.5 to $2.5 million to repair, leaving the machinery inoperable for between 90 to 180 days.^[12] Seeing as how 84% of Union Drilling's revenue comes from daywork contracts, or contracts that are paid on a negotiated fixed rate per day while the rig is used,^[2] taking time and capital to upgrade and repair rigs is costly. Such repairs and replacements have led to a 38% decrease in earnings for Union Drilling in October 2008 when the company added two new rigs to replace older, idled rigs in the Appalachia.^[17]

Seasonality Dictates Operational Ability, Limits First and Fourth Quarter Growth

Land drilling, especially in the Appalachian Basin, is subject to unfavorable weather conditions and often in difficult terrain. Cold, snow and mud hinder Union Drilling's operations, especially during the Winter and Spring. Local and state governments place restrictions, known as "frost laws" on the movement of drilling equipment during various times of the year, namely when roads are vulnerable to damage from the movement of such equipment. Frost laws and winter weather lead to adverse performances in the First and Fourth quarter.^[18] Union Drilling's first and fourth quarter for FY 2007 were the lowest performing, indicating in part the impact of these forces. ^[19] In FY 2007 and FY 2006, the quarterly highs for the fourth quarter were on average 8% lower than the quarterly highs for the second and third quarter.^[19] Also, the quarterly highs for the first quarter during this time period were on average 10% lower than the quarterly highs for the second and third quarter.^[19]

Competition

Union Drilling distinguishes itself from its competitors by offering horizontal and underbalanced drilling capabilities. Union's competitors are unique to each area of operation in which Union Drilling markets. In the Appalachia, Union Drilling is the largest and only public driller, competing only with smaller companies.^[20] In the Arkoma Basin and in northern Texas, Union Drilling competes namely with Nabors Industries (NBR).^[8]

Union Drilling's Main Competitors

• Nabors Industries (NBR)-- Nabors Industries is an international land drilling contractor with approximately 535 land drilling rigs in North America, South America, Mexico, the Caribbean, the Middle East, the Far East, Russia and Africa.^[21]
• Grey Wolf (GW)-- Grey Wolf is an American-based land drilling contractor with a rig fleet of 121 rigs. Grey Wolf does its business in the Gulf Coast; Mississippi/Alabama; Arkansas-Louisiana-Texas; the Rocky Mountain, as well as in the Mid-Continent.^[22]
• Pioneer Drilling Co (PDC)-- Pioneer Drilling Co is an American-based land drilling contractor.^[23]

Market Share

Union Drilling only accounted for 5% of the United States' contract drilling market.^[8] The market was largely dominated by Nabors Industries (NBR) who is a direct competitor to Union Drilling in the Arkoma Basin in eastern Oklahoma and Arkansas as well as in northern Texas.^[8] Union Drilling's other main competitors, namely in northern Texas, are Grey Wolf (GW) and Pioneer Drilling Co (PDC).^[8] Grey Wolf had a larger market share than Union Drilling, possessing 9% of the market^[24] while both Pioneer Drilling Co (PDC) and Union Drilling possessed 5% market share.^{[25] [8]}

This graph shows market share for the United States' onshore contract drilling market in FY 2007. Market share is determined by the number of rigs owned and operated by the respective drilling companies.^{[26][27][28][29][30][8][31][32]}

References

1. ↑ ^{1.0 1.1 1.2 1.3 1.4 1.5} UDRL 2007 10-K; Part 1: Business, Page 1
2. ↑ ^{2.0 2.1} UDRL 2007 10-K; Part 1: Business, Page 4
3. ↑ "Low oil prices: Good for us now, bad for us later?"
4. ↑ Perincheril, Biju. Union Drilling, Fortis: Initial Coverage. (Fortis Equity Research, 11 June 2007)
5. ↑ ^{5.0 5.1 5.2 5.3 5.4 5.5} UDRL 2007 10-K; Part 2: Selected Financial Data, Page 25
6. ↑ ^{6.0 6.1 6.2 6.3 6.4} UDRL 2007 10-K; Part 2: Selected Financial Data, Page 20
7. ↑ UDRL 2007 10-K; Part 1: Business, Pages 2-3
8. ↑ ^{8.0 8.1 8.2 8.3 8.4 8.5 8.6 8.7} UDRL 2007 10-K; Part 1: Business, Page 3
9. ↑ UDRL 2007 10-K; Part 3: Selected Financial Data, Page 20 & 25
10. ↑ ^{10.0 10.1 10.2} UDRL 2007 10-K; Part 1: Business, Page 2
11. ↑ UDRL 2007 10-K; Part 1: Business, Pages 2-3
12. ↑ ^{12.0 12.1 12.2} UDRL 2007 10-K; Part One: Business, Page 11
13. ↑ Carter, Ray. "Drilling industry problems restrict exploration". Business Net (August 14, 2001)
14. ↑ "Oil & Gas Well Drilling Industry Overview". Hoovers (Accessed December 8, 2008)
15. ↑ Reeh, Foon. Obama Promotes Alternative Energy Plan. Political Intelligence (October 14, 2008)
16. ↑ Rascoe, Ayesha. "Environmentalists look to Obama to limit drilling". Reuters (November 10, 2008)
17. ↑ Union Drilling’s profit drops. Dallas Business Journal (October 30, 2008)
18. ↑ UDRL 2007 10-K; Part One: Business, Page 8
19. ↑ ^{19.0 19.1 19.2} UDRL 2007 10-K; Part One: Business, Page 17
20. ↑ Perincheril, Biju. Union Drilling, Fortis: Initial Coverage. (Fortis Equity Research, 11 June 2007)
21. ↑ ^{21.0 21.1} Industries Inc&um=1&ie=UTF-8&sa=N&tab=we NBR-Nabor Industries Ltd. Google Finance (2008)
22. ↑ ^{22.0 22.1} GW-Grey Wolf, Inc. Google Finance (2008)
23. ↑ ^{23.0 23.1} PDC-Pioneer Drilling Company Google Finance (2008)
24. ↑ Grey Wolf, Inc. Summary
25. ↑ Pioneer Drilling Company Rig Fleet List
26. ↑ Pioneer Drilling Company Rig Fleet List
27. ↑ Grey Wolf, Inc. Summary
28. ↑ Nabors Industries Ltd Summary
29. ↑ Patterson UTI Summary
30. ↑ Helmerich & Payne Rig Fleet
31. ↑ Rowan Companies Land Rig Fleet
32. ↑ Parker Drilling Fleet