Drillers seek ways to maintain capital discipline while still investing to keep rigs competitive

By Stephen Whitfield, Senior Editor

Dan Hoffarth is CEO of Citadel Drilling.

What would you say are some of the biggest challenges the industry faces in the unconventional space, and how do you think the industry should address those challenges?

I think we need to go back and look at what happened in 2022 and 2023, so we can figure out where things need to go in order to have a more desirable outcome in 2024. What we’ve seen is decreased gas prices really hitting in places like the Haynesville, the SCOOP/STACK and the Eagle Ford. That drop in rig count has a direct impact on everyone’s books. It’s a major key indicator to understand that we need both consistent gas and oil prices for drilling contractors to have a decent business model.

We have a bunch of super-spec rigs sitting on the sidelines because of the drop in gas prices. That creates market pressure, which creates pricing pressure and a loss of jobs. You’ve got 15 to 18 people per rig, and then you add on the associated services, so we’re talking around 150 jobs per rig. Where do those people go during a period of inactivity, and what does the industry do when gas prices recover?

I believe they will recover in 2024, and we’re going to have to go back to the market and try to find some of these people. A lot of them will say they’re not coming back to the oilfield because they found another pretty decent job without the ups and downs. As an industry, how do we continue to fight the cyclical nature of our business where we are putting people to work and then letting them go?

I think the biggest critical issues for us are still going to be focused on utilization and people, but I believe that 2024 will be a better year than 2023 – or at least, the back half of 2023.

I guess the cycles are just part of the industry, aren’t they?

I mean, that is the industry. We have to be able to manage our assets based on a cyclical outcome. We’ve never had anything other than cycles in the drilling space. More than just people, that also creates challenges around equipment. How are we going to meet operators’ equipment needs when we don’t have a confident view on utilization?

More importantly, how can drilling contractors be expected to invest the capital required to improve and maintain top level equipment if there is not a clear path to both payout and profitability? That’s going to continue to be another major challenge for the industry as we move forward.

You mentioned the super-spec rigs. As gas prices go back up, how important will it be for drillers to have those rigs ready to work quickly?

The best rigs in the market get picked first every time. Super-spec rigs have proven time over time to create the greatest degree of production per day of any unit of machine. To me, that’s paramount.

For any operator, if you have that choice, you’re going to want the higher pump capacities. You’re going to want the higher torque capacities out of the top drive. You’re going to want the greater racking capacity. You’re going to want to have a moving system, a handling system for the BOPs and the most advanced fluid handling systems. And then you’re going to want all the digital applications.

When we take a look at production per rig year over year, and why we need fewer rigs to produce more than we did 10 years ago, it’s the quality of the equipment. It’s also important to look at the quality of the people, the quality of the digital assets, the quality of the engineering – but none of that can shine if you don’t have the machine behind you that has the capacity. You cannot race a Formula One race in a stock car. It doesn’t matter who your driver is, or who your pit crew is, or what the track is. You will finish last in every race.

For the past few years, we’ve seen a focus on capital discipline from E&Ps, and that’s had a trickle-down effect throughout the industry. Even now, the most recent quarterly reports from E&Ps have touted returning cash to shareholders. As we see a gas price recovery, do you think capital discipline will still be the MO for the industry moving forward? If so, how does that affect your business?

We need to maintain a balance with regards to every part of our business. On one pillar, we need to have balance with our equipment – keeping our equipment at a super-spec level and in top shape. On another pillar, we need high-quality employees who can thrive in this business. The leadership team is the third pillar – having leaders who can see where the business needs to go and how to evolve that business.

But then there’s a fourth pillar, which is shareholder health. If we don’t have shareholder health, I don’t see how you can succeed. The shareholder requires a margin on their investment. I can’t think of a shareholder out there in a personal or corporate capacity that will knowingly invest in any company without the expectation of a full return on that investment plus a premium. There’s a very basic expectation of getting a return on your investment, and that’s rarely happening, if at all, in the contractor space.

I am also not saying it’s been happening that much at the operator level either, but in today’s world when the typical investor makes a choice to invest in the energy space and they can choose between a drilling contractor or an oil company – rarely do they choose the driller.

It’s always great to focus on growth, but if that growth isn’t translating into shareholder return, you need a different model. So, I think capital discipline is going to be a continued focus for everyone moving forward.

From a spending perspective, how do you maintain the balance of being disciplined while still investing in the equipment that keeps your rigs competitive? Are there any areas where you see a bigger bang for the buck?

The number of newbuild rigs have always been the canary in the coal mine telling us whether we’re successful in maintaining that balance. We aren’t seeing a single North American land-based drilling contractor building new rigs right now, and they haven’t for years. Obviously, that balance was not there, and it continues to not be there.

What are our options, then? For those of us that are in the super-spec rig space, the key priority is maintaining super-spec status. We went from the three-generator to the four-generator models. We’re continuing to increase racking capacity. Drill pipe selection has continued to evolve. We’re looking to increase pumping capacities across the board. And then we started looking at all the areas where we can become more streamlined in our operations.

On top of that, we’re continuing to drill wells faster and faster. For Citadel Drilling, between 2019 and 2022 we drilled an extra 37 wells year-over-year on average. The average days per well went down from 23.8 days to 18.4 days in that time frame. Our total footage drilled in 2022 was 320,000 ft higher than what we drilled in 2019. We’re not staying flat. We’re still finding ways to increase production. The equipment is not taking a break, so you have to take maintenance extremely seriously. In 2022, we worked our rigs every single day. In 2023, the only days our rigs didn’t work was during the recertification process.

However, going back to what I said earlier, shareholder value has to stay in the forefront. We can’t spend every dime we have on upgrades. We have to generate returns.

What are you doing on the digitalization front?

One of our primary focuses has been the integration of digital products and equipment. We didn’t know what that was going to look like, but we had to have the flexibility to go down those roads.

So, owning our own operating system was a key element for us to maintain that flexibility. We’re one of the few drilling contractors that has its own software for an operating system. On one side, we focus on programmable drilling features, such as auto driller, MPD, ECD management services, as well as other inter-program things like auto-downlink for RSS tools, auto trip, auto pipe working features and anti-collision.

On the other side of digital assets, we partner with companies that excel in that space and integrate that technology into our rigs to ensure we provide our clients with the most modern and optimal solution the industry has to offer.

We’re seeing an increase in lateral lengths in unconventional wells, and now three-mile laterals are becoming more commonplace. Is today’s rig equipment capable of consistently drilling these longer laterals, or are we going to need upgrades?

I think we can continue to push the thresholds there, but we’re always going to find a new weak link in that equation. At one point, with the three-mile lateral, the weak link was the drill bit. Then it was the fluids that we were using to maintain wellbore stability. Then it became a question of whether we can effectively frac at that distance. And we started checking off those things.

So, then it comes back to the drilling rig. What’s the full capacity of the derrick? Can we rack the vertical depth plus three miles of 5½-in. drill pipe in that derrick? I do believe there is a potential need in the future to have new substructures, new derricks and new racking boards with additional capacity. Pump pressure continues to be important, and pressure requirements are almost definitely going to go up. We’re also starting to look at whether to evolve from 10,000-lb to 15,000-lb pressure-pumping systems and what type of  substantial upgrade to drilling rigs that would require.

Can this all be done? Absolutely. Is there a cost to it? Absolutely. Is there an expected return on that cost? Absolutely. I don’t believe drilling contractors can continue to foot the bill for these upgrades without a return to their shareholders being an outcome of that equation.

Are drilling contractors and operators aligned on who should bear what costs, or is that a conversation the industry still needs to have?

It depends on what level that conversation is happening, and which companies are having that conversation. Everybody has a different view.

This is a conversation that requires a high degree of emotional intelligence. This isn’t about being adversarial. The operator’s shareholders can easily be the same shareholders that drilling contractors have, and if that shareholder doesn’t get the same degree or likelihood of return on their investment, in both places, they’re going to choose one company to back. As soon as one of those companies runs out of shareholders, we become challenged with the inability to create the outcome desired by the other company.

This is where you go back to the discipline of those companies. Some companies are going to have that discipline, and others may just need the cash flow to keep working so they might make a different decision. In the long run, the companies that maintain capital discipline and don’t take an emotional approach to these conversations are going to be the ones left standing.

Going back to digitalization, what’s your opinion on whether the industry is making the best use of its data? If you don’t think that’s happening, how can the industry get better at that?

I think the industry is still trying to figure out how to scrub the data for value, or what is relevant data they should be looking at. There are also legal challenges around data ownership.

One of the big disconnects I see of new technology being brought to market – you can maybe call it a criticism – is the condition under which it was developed. Was it developed under a condition where you have good relevant data, where you truly understand the dynamics of the product and the operator’s needs combined with the drilling contractor’s needs? That’s where you see a lot of the shortcomings in data and data transfers. How does this data directly translate to the tools we’re using? As we go up the ladder, how do we integrate that tool onto the drilling rig or into the process to generate a desired outcome?

Another disconnect I see is that many of these companies developing data-reliant tools don’t own drilling rigs and never have. Without that level of understanding of the day-to-day operation of the drilling rig, how do you know what to implement? Many times, a tool will look like a great plug-and-play model in the shop, but when you get to the rig site, who actually attaches it to the drilling rig? Who’s responsible for the maintenance of that product? Where is the labor going to come from to manage it?

The drilling rig moves a lot – different sizes of rigs that move from every few days to once or twice a month. When we’re moving the rig, who becomes responsible for the third-party equipment? How do we bring your tool down? How do we bring it up? Where does it sit?

As a drilling contractor, we see hundreds of service companies approach the E&P company with a doghouse proposition, and we’re left on the outside getting something handed to us that we have to use. And yet, we weren’t a part of the conversation. That makes it really difficult for that digital asset or new technology to be adopted with open arms.

That begs a question about standardizing digital interfaces. Citadel has its own OS, and you’re having to work with all these different systems, some of them coming from the E&Ps with little input from you. Do you think the industry is embracing some kind of standardization? If not, do you see that as a problem?

It is a problem, but it can also be a differentiator for a company. We’re in a free market. We don’t have standardization across drilling rigs. There are different pumps on the market that we can all buy. There are different top drives, different drill pipe. We get to make a free choice in regard to how we see our future play out, and that’s our bet to make.

If we had built the same rig that any of the most respected drilling contractors in the industry had, they would beat us senseless just with the volume of rigs that they have versus what we have. I can’t come to the market with the same product; I have to have a differentiated product and service.

This is a competitive industry, and I think that’s one of the things that keeps the industry moving forward the fastest. Standardization might seem like a really great concept to the digital provider, but to the smaller companies that are trying to get in, it limits our ability to exist or grow. Standardization is the fastest way to get something adopted by the most amount of people, but it cuts out new ideas, concepts and new entrants to the market.

As automated systems become more prevalent on the rig, where do you see the driller fitting in? Do you share the view that automation is there to enhance the role of the human on the rig, not replace him or her entirely?

I share the view that continuing to transfer tasks from human hands to more of a mechanized or semi-automated process is a good thing. Sequenced tasks, like a drill pipe connection, are the low-hanging fruit.

However, I do see humans continuing to play an extremely critical role on the rig. It goes back to that disconnect around integration with the rig – many of the companies bringing in high-level automation to the market don’t own or operate drilling rigs. Is it now another screen that has to be added because it doesn’t work inside the rig’s OS, and the driller now has one more thing to be trained on. If the result is to just bolt on another operating system, this now becomes an additional risk.

Every sales pitch says, “plug and play and walk away.” That’s great, but we then have to be able to ensure we can quickly develop competency among our drillers to use that equipment. You can’t expect the drillers to run everybody’s equipment, and that seems to be the expectation right now. We’re putting the driller into sensory overload.

The goal with automation is to create a more consistent outcome, but if we are creating task saturation, then we’ll actually create the opposite outcome.

Citadel offers fully automated managed pressure drilling (MPD) systems through your subsidiary, Opla Energy. What value do you think MPD will provide for the industry in the near-term future?

I look at MPD in two specific categories, and they’re opposite of each other. One is kick control and one is performance-based. On the kick control side, this is a cautionary equipment measure to just take on flow when we don’t want it to happen. This is a very large slice of the business out there today. The future of MPD, to me, is performance-based, and I don’t even know if you call it managed pressure anymore. It’s a performance-based business that leverages managed pressure drilling techniques.

I see these as two completely separate business segments. One is merely a flow control device that is utilized when problems are encountered. The other is a sophisticated combination of equipment, software and behind-the-scenes engineering that has a primary focus on well optimization and performance. With performance-based MPD, the goal is increased ROP, decreased fluid losses, decreased fluid costs, improved hole stability, and repeatability from well to well.

We’re moving toward a greater adoption rate of this equipment and, as the operators learn more about it, they’re going to see the need for this to evolve their wellbore delivery programs in a more efficient manner, as well.

The industry has seen a lot more focus on reducing rigs’ carbon emissions in recent years. What is your view on this, and has the energy transition had any impact on Citadel’s business?

It’s had a very big impact. Being a private company, we have private shareholders. Private equity sponsorship is dependent on competing for capital, and that capital comes from global sources, which demand you invest in an aligned sustainability approach. If you don’t do that, you’re not going to have access to that capital. Access to capital, combined with it being the right thing to do, is why sustainability is a big part of our business.

The trend of operator consolidation is also going to impact us. One example is Oxy’s acquisition of CrownQuest (a subsidiary of CrownRock) in December. While both companies have been focused on environmental performance and sustainability efforts, you now have two companies coming together under one entity and an even higher expectation on sustainability due to the public lens and nature of such a large deal.

As a drilling contractor, we have to take these types of consolidations into account and create that focus on sustainability. This goes back to what I said about maintaining the super-spec rig, including investing in dual-fuel engines. If you don’t have them, you’re out, or you’re going to have to buy them. That’s going to be a price tag to entry. By our calculation, we saw a 54% reduction in CO2 generated per foot drilled by utilizing dual fuel compared with diesel engines from 2019 to 2022. While we have had all engines with dual-fuel capabilities on all of our rigs from day one, we are now reaping the benefits of this decision.

Speed is another tool we have. For a drilling contractor, continuous improvement on ROP is going to be important. That goes back to my point about having the best equipment that’s going to drill the fastest, and having the best people who are going to drill the fastest.

By reducing the time to drill per well, we may be generating the same emissions over the course of a fully utilized year, but we create more wells. If we increase the level of performance, we also increase our sustainability. The end result is a higher well production count per emissions output year over year.

The young workers coming up have placed an increased value on sustainability. How do you reach out to people who have serious concerns about the industry’s role in climate change?

I have those concerns. I had those 30 years ago. Honestly, I think the best conduit to change is not to fight that system, but to join that system and become a part of the improvement from within. We need this energy, and this energy is going to be produced regardless of who does it.

My pitch to the young people is, if you have a moral connection to this and you want to improve it, the best place to do it is inside these companies. Become a drilling engineer that has the focus on creating the lowest carbon footprint per well possible. Become a superintendent in a drilling contractor company and ensure the moral performance of that company. That can only happen from the inside.

What are your main concerns around rig safety right now?

To me, it’s the level of care. I’ll go back 30 years to the early parts of my career. Where did we get our roughnecks from then? Well, they were brothers and cousins, they were from the family two farms over, they were a best friend of somebody that they knew. We didn’t have formalized HR departments. A lot of times, the drillers and rig managers were responsible for staffing their own rigs. You invested your time in this person to keep them safe because you had a moral obligation to them, their family and your family.

To me, that’s still the primary way for us to impact safety around a rig. It is a personal target. It is a personal goal. It is about people. We can add on all the wearable technology, and we can have the computer-generated training programs, but those are all just tools to assist. Creating safety is just a deep amount of caring for people, and that has to be a cultural achievement of your company. To me, that’s where the industry has failed the most, and that’s where the industry could increase our performance to the greatest degree. We’ve got to continue to care for each other at a level like we’re related. DC