Sustained higher crude oil and natural gas prices lead energy companies to increase drilling activity, creating a strong outlook for oil country tubular goods.

Editor’s note: Information and comments contained in this article were gathered prior to Hurricane Katrina, which did extensive damage to oil-industry facilities in the Gulf of Mexico.

By Myra Pinkham,
Contributing Editor

Demand forecasts are glowing for all energy-related steel pipe and tube products—not just oil country tubular goods, but also line pipe. Even large-diameter line pipe, which has lagged the rest of the energy tubulars market, has shown signs of life as the North American drill rig count has soared to a 20-year high along with natural gas and crude oil prices.

“The economics are very positive for oil and natural gas exploration,” says Ken Hayes, director of standard and line pipe for Red Man Pipe and Supply Co., Tulsa, Okla. Oil and natural gas prices are simultaneously high, which doesn’t often happen. “Everyone with a drillable prospect is drilling it.”

The surge in crude oil prices has been widely publicized, with prices closing Aug. 31 at $68.94 a barrel for October delivery on the New York Mercantile Exchange. For comparison, crude oil sold for about $26 a barrel as recently as 2002.

In the United States, natural gas is more important, says John Mocker, vice president of Lally Pipe & Tube, Covington, Ky. He notes that 85 percent of all drilling in the United States, and 60 percent of all drilling in North America, is performed to extract natural gas. The need to continue drilling for natural gas is likely to remain strong here, he adds.

Several studies, including a recent one published by the Interstate Natural Gas Association of America’s INGAA Foundation, reveal a growing need for clean-burning natural gas, says Larry R. Lawrence, vice president of sales for Oregon Steel Mills Tubular Products, Portland, Ore. This has contributed to the continued strength in natural gas prices, which have been firm for the past two to three years, agrees Scott Lauschle, marketing manager for industrial and energy alloy steel at The Timken Co.

Nymex natural gas futures prices at the close of Aug. 31 hit $11.472 per MMBtu for September delivery. For comparison, natural gas sold at between $2 and $4 per MMBtu in 2002.

Recent strong commodity prices have had a direct effect on drilling rates in North America and throughout the world. “As prices go up, some harder-to-drill reserves become viable,” explains Donald R. McNeeley, president and chief operating officer of Chicago Tube and Iron Co., Chicago.

Examples of this include deep water drilling in the Gulf of Mexico and the development of new prospects in Canada’s oil sands. With the U.S. administration’s stated desire to rely less on Middle Eastern oil, there also has been more exploration of oil reserves in South America, McNeeley adds.

The steady, sustained increase in wells deeper than 15,000 feet has created not only additional need for drill rigs, but additional consumption of tubular goods per rig, especially higher value alloy products, says Charles J. Keszler, vice president and chief financial officer for Lone Star Technologies Inc., Dallas.

This deep-drilling trend has prompted several mills to increase production of OCTG alloy products. For example, Maverick Tube Corp., St. Louis, plans to double its alloy OCTG capacity from about 140,000 tons to almost 300,000 tons in the first quarter of 2006. The company says it will examine other opportunities to step up production even further, both domestically and internationally.

Maverick expanded its international presence in June by acquiring Colombia’s Tubos de Caribe, which makes OCTG and line pipe.

Rigs counting up
Drill rig counts definitely are on the rise in North America. Baker Hughes Inc. reports that 1,993 rigs were operating as of Aug. 5, up 23 percent from a year earlier. That total includes 1,436 rigs in the United States, up 16 percent; 557 in Canada, up 45 percent; and 101 in the Gulf of Mexico, up almost 9 percent. The last time the U.S. rig count reached this level was nearly 20 years ago, in February 1986.

Rhys J. Best, chairman and CEO of Lone Star, notes that some drilling contractors plan to refurbish old rigs, bringing them back into service this year and next, in addition to the many others that have announced plans to build new rigs.

Even with indications that energy prices will remain strong for at least 12 to 18 months, some observers doubt the rig count can continue to grow at this rate. “We will run into certain constraints,” predicts Don Alexander, president of Alexander Steel Sales Inc., Temecula, Calif., pointing to a shortage of workers to man the new rigs.

Tracking with the rig count is demand for tubular goods. “OCTG activity started to ramp up in 2003 and has continued a steady increase to a level we haven’t seen in some time,” remarks Rick Preckel, director of investor relations and business development for Maverick Tube.

Rene J. Robichaud, president and CEO of NS Group Inc., Newport, Ky., says orders for OCTG increased about 20 percent in the past 12 months and should remain robust as long as energy prices are strong.

That view was echoed by John Tulloch, executive vice president of steel for Ipsco Inc., Lisle, Ill. “There is a need for more energy to be supplied. Anything related to the energy sector will be strong.”

OCTG consumption reached a milestone in June at 300,000 tons, which is the highest level since 1985, says Doug Yadon, publisher of the Preston Pipe Report.

Domestic OCTG production has some serious competition from foreign mills, however. U.S. imports, especially of carbon steel energy tubing, rose about 65 percent from a year ago, Yadon says. This growth includes a 252 percent increase from China, a 111 percent increase from Spain, an 88 percent increase from Turkey, a 74 percent increase from Germany and a 67 percent increase from Canada.

The result is an increase in import penetration to 39.7 percent in May vs. 26.4 percent two years ago. This growth in imports has caused supply to exceed demand by 35,000 to 40,000 tons per month and inventories to exceed six months of supply.

China is clearly the major culprit, Yadon says, as it now controls one-third of the United States’ import supply and almost 10 percent of the total U.S.
market.

Excess supply is likely to lead to discounting, experts say. “We have now crossed the line where pricing pressure will increase disproportionately. I predict that the OCTG pricing structure will collapse in the next 12 to 18 months unless this import trend is reversed immediately,” Yadon says. He adds that antidumping actions, and even the filing of a Section 421 trade restriction petition, are being considered against China.

Until now, domestic producers have only filed a Section 421 petition on China’s exports of standard pipe to the United States. A hearing on that petition, filed Aug. 2, is to be held in mid-September, and a decision by the International Trade Commission is expected by the end of the month.

Hayes at Red Man says that while imports are having an effect on OCTG, the impact isn’t nearly as bad as that for standard pipe.

Maverick Tube’s Preckel says it is not unusual for imports to rise when the OCTG market is strong. He admits that this could cause some weakness in pricing of the lower grades should the pace of imports outstrip U.S. demand, “but I don’t see that happening at this time.”

Although tube imports have contributed this year to the decline in the domestic price of carbon flat-roll, which is used to make tubular goods, NS Group’s Robichaud expects that pressure to ease in the second half along with imports. A large portion of the tubular import tons were ordered at the end of 2004 when supply was tighter, he notes.

German Cura, executive director, commercial, for Tenaris, a global tube maker with mills in North and South America and Europe, asserts that imports ordered during the second half will be primarily for items that aren’t widely produced by domestic mills or those that are in tight supply.

“There is plenty of pipe in the marketplace,” and no hint of shortfalls to come, says Edward “Bud” Siegel, president and CEO of Russel Metals Inc., Mississauga, Ontario.

That is especially true on the commodity end, another OCTG distributor says, citing lead times as short as 35 to 40 days. However, he adds, supplies are fairly tight for certain products that are heat treated, quenched or tempered with lead times from 60 to 90 days for smaller diameters and up to 120 days for larger diameters.

Lead times are also tight for alloy grades, required for the deeper wells, and for seamless products. Hayes says lead times for the heavy wall, high-yield, large-diameter seamless pipe used for deep-water applications is out three to six months.

Seamless supply could be eased somewhat should Rocky Mountain Steel Mills restart its seamless OCTG pipe mill in Pueblo, Colo., which was shuttered in November 2003. The company expects to make a decision about that mill by October.

Pricing and margins
Despite the oversupply of some products and pressure from imports, OCTG prices have actually grown 20 percent from a year ago due to the strong demand. But that momentum has slowed a bit recently, says Kurt Minnich, partner of Spears and Associates, Tulsa, Okla., the publisher of Pipe Logix.

Seamless prices continued to rise this summer, though at a slower pace, while prices for electric resistance welded tubing were flat, he says.

Market participants attribute the weakness in ERW pricing to higher imports, but Mocker at Lally Pipe & Tube also cites weaker prices for flat-rolled steel, from which ERW pipe is made. Flat-roll prices fell to $440 a ton at the end of July from $660 a ton in January.

Preckel notes that OCTG margins have remained strong because tubular prices have not declined as steeply as those for sheet and coil.

Line pipe vs. OCTG
“Line pipe isn’t as strong as OCTG. But on an overall basis, it is still decent and likely to get better, as there is a need for carrying capacity to get natural gas from the drilling fields to the marketplace,” says Siegel at Russel Metals.

Hayes says that smaller diameter line pipe (4 to 8 inches) used for gathering-system and well-connect activity is a little stronger than larger diameter product, which had been unusually weak until early July. But even large-diameter line pipe is now seeing an uptick in demand. “Perhaps this is the beginning of the waited-for run on those sizes. Only time will tell for sure,” he adds.

It’s no surprise to Ipsco’s Tulloch that line pipe is doing well, as this product tends to follow drilling activity along with OCTG. “You don’t only have to find oil and gas, but you need to transport it as well,” he says.

The correlation between drilling and demand is not as direct as with OCTG, however, because “there are already about 2 million miles of line pipe out there working fine,” Robichaud explains.

What promotes the need for small- and medium-diameter line pipe (sizes that are more in sync with drilling activity than large-diameter) is whether there are established gathering lines associated with the rigs, Preckel says. “When you are drilling in new locations, there is additional business for new gathering and transmission lines.”
Demand for small- and medium-diameter line pipe is more likely to help

distributors than that for large-diameter product, as larger pipe tends to ship mill direct.

While orders for all small and medium line pipe have been strong, supply of seamless product is much tighter than for welded, reports Jim Owsley, vice president of material sourcing for Wilson Supply, Houston. All the major seamless mills have buyers on allocation, largely due to heat-treated OCTG taking much of the capacity often reserved for line pipe, he says. While some new capacity has come on-stream, including in China, many domestic buyers are leery about the quality of foreign product.

Oregon Steel Mills expects to fully utilize its ERW capacity in the next two to three years. In the first quarter of 2006, OSM will start up two new spiral double submerged arc weld pipe mills with a combined capacity of 150,000 tons.

Funding for line pipe projects
Large-diameter line pipe is further disconnected from the rig count and tends to be more project driven, says Preckel. Many such projects, on hold for the last several years, may finally move forward.
Yadon expects the large-diameter line pipe market to “go like crazy” next year with an increase of about 20 percent as several projects get funding.

“About 100,000 tons of orders have been placed for next year in just the last few months,” says Ron Williamson, vice president of sales for Berg Steel Pipe Co., Panama City, Fla. “All the transmission companies are very active. If they are not placing orders, they are making inquiries to budget work for next year.”

Everyone’s keen to hear news about mammoth projects such as the coveted Alaskan pipeline, slated to consume more than 2 million tons of line pipe once construction begins.

Many were hoping the new energy bill would help promote drilling and pipeline projects, such as the Alaskan pipeline, but the final legislation may not bring about much change. While it provides tax breaks and other incentives to encourage more production of oil and gas, and to improve natural gas and electricity transmission lines, it does not open the Arctic National Wildlife Refuge to oil drilling.

Congress is expected to consider that proposal separately when it reconvenes in September.

In any case, Mocker says, “Even if opening ANWR for oil drilling occurs, we will not see any benefit in additional oil production for almost 10 years.”