February 2017

OCTG's Rising Off the Bottom

The market for energy pipe and tube products bottomed out in mid-2016 and appears to be in the early stages of an extended rebound.

By Dan Markham, Senior Editor

Virtually all the fundamentals are pointing toward a stronger year for the energy market and the oil country tubular goods producers and distributors who supply it. While no one expects a swift recovery for the beleaguered oil and gas industry, the optimism heading into 2017 is palpable throughout the supply chain.

The global oversupply of oil has pushed prices to near-historic lows and derailed drilling for more than two years.

The pipe and tube industry has responded by curtailing production and working off excess inventories in the system. With oil prices back up over $50 per barrel, from $30 lows last year, there’s new activity stirring in North America’s oilfields.

“I told customers on Jan. 1, 2016, that I was looking forward to 2017. And it was worse than I thought. Anybody who went through last year suffered,” says Jeff Hanley, vice president of energy products for Welded Tube of Canada, Concord, Ontario.

“I think this was the fourth significant downturn in my almost 40 years in the industry,” says John Mocker, vice president of Lally Pipe & Tube, Covington, Ky. “This has been the deepest and the longest.”

The market hit its low at mid-year when rig counts in North America fell to just 450, according to oilfield services company Baker Hughes, Inc. From that point, industry watchers began to see slow improvement. By December, the rig count had almost doubled to 843. In the U.S., the count jumped from 611 in May to 834 at year’s end.

“Everybody watches the Baker Hughes rig numbers every Friday like they’re the lottery numbers. In May, we saw the inflection, though 30 percent improvement on a low denominator still isn’t great,” Hanley says. At the peak in 2008, more than 2,000 rigs were pumping full tilt in North America’s shale plays.
The numbers have continued to rise in the first quarter. “We’ve seen some big gains in the rig count since the start of the year,” says Kurt Minnich, who analyzes the pipe and tube industry for Pipe Logix, Tulsa, Okla. “We’re up 60 percent in the rig count from the low, and that translates into more demand for OCTG.”

Industry suppliers are already feeling the effects. “We’ve started seeing higher inquiry volumes. We will see more positive movement in the market by the end of this quarter,” says John Hritz, president and CEO of JSW Steel, an Indian-owned plate and tube mill in Baytown, Texas.

In late 2016, OPEC announced plans to curtail production by more than 1.2 million barrels per day. Other major oil-producing countries outside of OPEC also agreed to curb output by 558,000 barrels per day. That should reduce the oversupplies of oil on the world market and help sustain oil’s price gains. “There are some encouraging signs that OPEC will deliver on its promised output cuts,” says Eklayva Gupte, senior editor for S&P Global Platts. “But the crucial situation is whether OPEC and non-OPEC can make the companies stick long enough to clear out the overhang.”

Meanwhile, energy pipe and tube stocks are finally coming into balance. The industry has been dealing with a severe oversupply for the past few years, a problem brought on by the sudden decline in demand and worsened by heavy import penetration. Domestic pipe mills, which have slashed their output in response to the energy crisis, will take care to ramp back up as conditions improve, experts predict. OCTG imports declined by more than 50 percent in 2016 (see chart on page 18).

“The market is operating at about seven months of inventory, and a portion of this inventory is obsolete,” says Luca Zanotti, vice president and managing director of U.S. operations for Tenaris. “So, the usable inventory is even lower.”

Al Rheinnecker, CEO of American Piping Products in St. Louis, says his company spent much of 2016 winnowing its stocks. “Our inventory is in good shape today because of what we started nine months ago.”

Pricing has begun to reflect the improving demand. Pipe Logix reported price increases for all OCTG products in December, with the average price climbing to $1,152 per ton. December was the seventh consecutive month that saw gains. Pricing improved for welded pipe, as well. “Welded pipe has been up dramatically the last three months, 10-15 percent,” Rheinnecker says. “Nobody is sure if that’s demand driven or due to raw material increases.”

There is also a geographic tilt to the market. The Permian Basin in West Texas and New Mexico is very strong, with additional activity in South Texas, Oklahoma and the Marcellus Shale in the Northeast. Part of the reason is increased use of horizontal drilling techniques, which consume greater quantities of pipe.

“The continued growth of horizontal wells with extended laterals is what’s marking the biggest change for OCTG. These laterals are growing every year,” Minnich says. In contrast, “anything that relies on a conventional kind of completion tends to be a little weaker because they don’t get quite the initial production rates they need.”

The Canadian market is expected to strengthen along with the U.S., though Hanley notes that Western Canada’s ability to take advantage of the improved conditions is delayed because of the pending spring breakup, the period
when the ground thaws and muddy conditions bring activity in the region’s oil patch to a standstill. “Our customers go into hibernation. Right now, they’re trying to get organized for what will come out of hibernation. It’s just a timing issue.”

The final cause for optimism among pipe and tube players is the change of administration in Washington. The election of Donald Trump is being greeted warmly for several reasons. It’s assumed he’ll enact more business-friendly policies and address burdensome regulations.

“We’re not just optimistic. We’re ridiculously optimistic,” says Hritz, pointing to Trump’s focus on American manufacturing.

Trump is also expected to be more fossil-fuel friendly than his predecessor. Minnich says the line pipe segment is the most likely to benefit from favorable Trump administration policies.

Almost on cue, in his first week in office, the new president issued a memorandum opening the door for completion of the Dakota Access pipeline and reviving the Keystone XL pipeline, which will transport energy products from Canada to refineries on the Gulf of Mexico.

“I don’t think Trump is going to be a panacea, but the [regulatory] environment is going to be a lot better,” Rheinnecker says.

 [For service centers in the oil patch, there is a new cause for concern. Global pipe and tube producer Tenaris plans to bypass the traditional supply chain and send material straight from the mill to the oilfields. OCTG distributors are watching this experiment closely to see if other mills follow suit.

Luxembourg-based Tenaris is committed to its Rig Direct model, which it employs in other parts of the world. Through Rig Direct, it delivers product, as well as technical consulting, pipe management services and field support—the traditional purview of service centers. It has begun the process in the South, with plans to introduce it to customers in the northern half of the U.S. and into Canada.

“We believe this is more efficient. We are saying this not because we did some mathematical calculation, but because we know this is the way the oil and gas industry is working all over the world,” says Luca Zanotti, vice president and managing director of Tenaris’ U.S. operations.

Rig Direct is coming fully online as the company ramps up operations in the U.S. Its 600,000-ton seamless mill in Bay City, Texas, is nearing completion. The company also added its own service center in the Permian Basin in Midland, Texas, a development the company says is critical to the implementation of the program. The $36 million facility will handle storage,
inspection, rig preparation and delivery of OCTG, accessories and sucker rods. In the future, it will provide coil tubing.

Disrupting the status quo was Tenaris’ intent. “We have laid the groundwork for what we believe will be the future of the tubular sector, our new go-to-customer model,” says Zanotti. “The concept was developed because we believe there are a lot of inefficiencies in the market, and by streamlining the supply chain, we can reduce those inefficiencies.”

There will still be room in the market for the traditional distributor, Zanotti adds. “Everybody will have their own role. What we are doing is proposing an alternative way. There are customers who will follow this, and customers who, for different reasons, will rely on the traditional supply chain.”

Kurt Minnich, publisher of Pipe Logix, Tulsa, Okla., says the Rig Direct approach is very upsetting to the traditional way of doing business. Opinion is mixed on how Tenaris will fare in distributing its own products. “We’ve seen it in other areas of the oil patch, but for OCTG this is a new step. It remains to be seen if OCTG is the right product for it.”]

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