Onshore drilling contractors turned in strong earnings in the fourth quarter last year; their operating income was 355.6% higher than in 2002's fourth quarter, on revenues that were 48.4% higher. Offshore drillers were a mixed group-some improved from last year's quarter, and others did not. As a whole, the group went from a loss in the fourth quarter of 2002 to a gain in last year's final three months, but the results were skewed due to a large impairment charge taken by Transocean Inc. in the fourth quarter of 2002. Looking ahead, analysts see good times coming for offshore drillers. In shallow-water markets, the Gulf of Mexico is seeing higher dayrates, and the outlook is positive internationally as well. Weak areas such as the Pacific Rim are seeing increasing demand, and other soft areas such as the North Sea and West Africa offer numerous signs for improvement in activity levels beginning in the spring to summer months, analysts say. These trends could lead to dayrate acceleration in the second half. In the deepwater rig market, there are very early indications of a recovery coming in 2005. And even in the still tough midwater market, there have been a few encouraging signs, such as some recent tenders that will help absorb excess capacity in the North Sea. Those tenders went to Transocean. The Transocean Leader and Jack Bates, both semisubmersibles, were contracted for drilling programs offshore Norway and the U.K., respectively. Statoil awarded the Transocean Leader an estimated 15-month contract for drilling on the Norwegian continental shelf, beginning in May. Currently, the rig is idle in the U.K. sector of the North Sea. Total awarded the Jack Bates an estimated 100-day contract in the U.K. North Sea, beginning April 1. The midwater sector, however, still has a long way to go. "We expect limited likelihood for a turn in mid-depth semisubmersibles," says Angeline M. Sedita, an analyst with Lehman Brothers. The deepwater rig market, on the other hand, has likely reached its turning point. "Consistency is not yet there, and the majority of the rigs remain on well-to-well contracts; however, we have finally hit bottom, and deepwater development opportunities may begin to materialize into real work over the next several years," Sedita says. The catalyst for deepwater drilling is dependent upon West African development projects moving forward, which may begin to occur in late 2004 and in 2005, she adds. Recently, affiliates of ExxonMobil contracted Transocean drillship Deepwater Discovery for a two-well, estimated 90-day drilling program offshore Nigeria. In the shallow water, the Gulf of Mexico jackup market in 2004 will look very much like it did in 2003-rig supply will continue to decline, and the trend will be toward deep-shelf drilling, says Gary Nuschler, an analyst with Sanders Morris Harris. Twelve jackups left the Gulf last year, and potential demand out of Mexico, the Middle East and India could draw additional rigs this year, Nuschler adds. Rowan Cos. hopes to move two to three jackups out of the Gulf, and is bidding on opportunities in Qatar, the North Sea, Argentina and Trinidad, according to Sedita. Rate potential in those regions ranges from $100,000 to $150,000 a day, versus the top rates in the Gulf of $65,000 to $85,000 day, she adds. All told, Rowan sees the potential for 12 to 19 rigs to leave the Gulf, which would prompt dayrate increases there. Grant Borbridge, an analyst with Prudential favors a broader geographic distribution for Rowan, given that 23 of its 25 rigs are in the Gulf. "However, it seems to us that Rowan management has been talking about opportunities outside the Gulf for some time, but with the exception of the Gorilla VII, has been either unwilling or unable to move rigs away from the Gulf," he says. Borbridge noted that the Gulf of Mexico jackup supply is at a 10-year low, and an exodus of rigs would drive up day-rates. Diamond Offshore HX reported that in the fourth quarter last year, its shallow-water fleet experienced its first operating profit in a year, Sedita says. Its Gulf jackups averaged a December dayrate of about $29,500, compared with $23,600 in January 2003. The company has completed a jackup upgrade program, leaving it well-positioned to benefit from tightening worldwide markets in 2004, she adds. On land, Sedita expects U.S. activity to start off strong in 2004, but to slow down in the second half under the assumption that gas prices will decline from current levels. In its year-end earnings announcement, Nabors Industries sounded a positive in its outlook. "In our U.S. Lower 48 land-drilling unit, we are seeing the early stages of an improved pricing environment in selected regions and horsepower clases," says Gene Isenberg, chairman and CEO. "I expect that by some time in the second half of 2004, the Baker Hughes U.S. land-rig count will have increased by more than 75 rigs from its 2003 highs." Robert Ford, an analyst with Sanders Morris Harris, notes that Precision Drilling had an outstanding quarter. Operating earnings per share were US$0.93, versus US$0.10 a year ago, and were US$0.16 ahead of Ford's estimate. The outperformance was due to better-than-expected pricing for both Canadian drilling and service rigs. "Weather permitting, Precision stands a strong chance of reporting record quarterly earnings per share in [the first quarter of 2004]," Ford says. Of course, the question is, what does all this mean for stock activity? In February, Sedita lowered her investment opinion on the contract-drilling group to neutral from positive, reflecting the group's strong share-price performance since the recent trough in the Philadelphia Oil Service Index in late November. "Clearly, industry fundamentals are improving, which should lead to some potential stock price upside; however, we believe that the stocks have discounted much of the recovery and that further share performance will be company-specific and not a sector move," she says. "Moreover, given the inherent volatility of the sector, investors may have an opportunity to enter the stocks at lower levels later in the year as gas prices settle." -Jodi Wetuski