Natural Gas Drilling Rigs: What’s The Play?

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With natural gas prices at their lowest levels in a decade, energy companies are shifting toward ways to use it in their oil and gas operations instead of costlier diesel fuel. A number of companies, particularly Caterpillar (NYSE: CAT), Cummins (NYSE: CMI) and General Electric (NYSE: GE), are poised to reap rewards along with them as the move accelerates.

As the Wall Street Journal recently reported, North America’s largest oilfield service players are spending millions to convert some drilling rig engines from diesel to natural gas power. The benefits, proponents say, are financial as well as environmental. To accommodate them, the Big 3 engine makers have begun marketing equipment that exclusively runs on gas or can accommodate either fuel — giving operators more flexibility as supplies and prices change.

The switch won’t be quick, and it is not feasible everywhere, but investors would be wise to keep an eye on the conversion and its impact on those who will benefit.

Gas technology expanding as market potential grows

Natural gas-powered drilling rigs have actually been an option for several years. Smaller private companies like Energy Conversions have been making kits for medium- and high-speed diesel engine retrofits for oilfield and railroad applications since at least 1984. Caterpillar began offering natural gas conversions in the late 1990s, and GE bought Austria’s gas-powered Jenbacher line in 2003 and began installing its products in North America three years later.

Until recently, however, most interest in the technology came from outside the U.S. in places like Trinidad, Nigeria and Thailand, where natural gas has been consistently cheap and located in close proximity to the proposed end uses. Observers estimate that only a few dozen of these natural gas engines are currently in operation in North America.

But the picture has changed dramatically in the past year or so, as gas prices plummeted and interest in its use in drilling applications rose. Caterpillar, the biggest engine maker in the market, announced at the HHP Summit in Houston this fall that it was going “all in” on natural gas and soon after introduced the first in a line of dual-fuel conversion kits for its industry leading 3512C engine.

At the same event, Cummins proclaimed its own support and said it would soon be offering conversion kits for its Tier 2 QSK50 and QSK Series Tier 4 engines. GE has subsequently been beefing up its gas engine division in an effort to capture more of a market that is sure to grow.

Response has been positive but challenges remain

This newly amped support from leading engine makers has been huge, as it adds their cachet along with their peerless aftermarket service operations to the mix while also limiting possible warranty issues stemming from the use of third-party conversion kits. As a result, major oil and gas producers including Apache, Encana, Anadarko Petroleum and Chesapeake Energy have shown increasing interest in the savings they can realize and are driving the big oil field service providers they utilize — like Schlumberger, Halliburton and Baker Hughes — to begin retrofitting existing rigs.

There are, however, obstacles to a quick and widespread adoption. One is a drilling culture that has been focused on diesel for decades and is filled with old-school players reluctant make any changes. Another is the depression in the North American rig count and the constant shuffling of drilling operations with each location having a different profile for natural gas price and accessibility.

This final point may actually prove the biggest stumbling block of all, with access to natural gas and applications to process it for use being both critical and still somewhat limited. Add in the cost of the technology — single-fuel diesel engines are about 50% higher in price than single-fuel diesels, and conversions run from $50,000-$250,000 per engine — and if the natural gas source is too far away the transportation costs could totally devour any savings the fuel change would offer.

Bottom line

The industry’s biggest suppliers and users are increasingly optimistic, however, contending the price break between diesel and gas should remain strong for the foreseeable future. And they say that for any operator who can truck the gas in or extend a pipeline to their rigs — or who have ready access to gas in the nearby area, like in drilling centers such as Wyoming — the payback on costs can be realized in as little as a year.

As a result, proponents predict the number of North American rigs that are run on natural gas will grow by as much as 300% over the next two to three years. If it does, investors keeping tabs on the progress could be among the beneficiaries.

TheChiefToo has no positions in the stocks mentioned above. The Motley Fool owns shares of Cummins and General Electric Company. Motley Fool newsletter services recommend Cummins. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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