U.S. Oil Rig Count Trends Lower, Shouldn’t Have Major Effect

Oil directed drilling activity in the U.S. continues to trend lower, with Baker Hughes (NYSE:BHI) reporting that drillers laid down another 56 rigs over the last week, taking the oil rig count to 866. The oil rig count is down by roughly 42% since the beginning of this year and around 46% from its mid-October 2014 highs. ^[1] The North American rig count has been a closely watched figure in the oil markets over the last few months, as investors and traders try to gain a sense of direction for oil prices by examining supply side factors in the U.S. land drilling markets, which have been the primary cause of the oil glut. In this note, we take a look at some of the recent trends in the U.S. oil rig count and its implications for oilfield services companies.

The total number of horizontal rigs (oil and gas) – used to target unconventional hydrocarbons – accounted for a bulk of the decline, falling by 46 units over the last week to 849. The horizontal rig count is down by about 37% year to date. The vertical rig count, which is an indicator of activity in conventional plays, is down by about 45% since the beginning of this year to 166 rigs. The decline in the rig count has also varied across the three principal tight oil plays in the United States. While the number of oil rigs in the Williston basin (where the Bakken shale is located) and the Permian basin are each down by 42% year-to-date to 104 and 311 rigs, respectively, the decline in the Eagle Ford shale has been more moderate at  32%, possibly owing to the regions lower marginal production costs and better takeaway capacity.

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While the decline in the oil rig count has been abrupt, we believe that it will not translate into a sharp drop in North American revenues for the oilfield services companies that we cover for two reasons. Firstly, the rig count only gives a sense of how many rigs are actively working and not the number of wells that are producing or the backlog of uncompleted wells. The productivity of rigs has been steadily increasing over the past few years, as operators employ technologies such as pad drilling to drill multiple wells using a single rig. For instance, production for each rig grew by 29% in the Bakken last year, according to the U.S. EIA. Secondly, the rig count is only a direct indicator of drilling and development related activity, which represents just a subset of the suite of services that oilfield services companies provide.

Demand for production-focused services is likely to hold up better compared to drilling services, as oil companies may choose to cut down on the number of new wells that they drill, but still extract maximum production from their existing wells. For instance, operators have been returning to already fracked wells to re-frack them and drive production instead of drilling and completing a new well from scratch. Given this trend, spending on production oriented services such as pressure pumping, artificial lift and enhanced oil recovery should hold up better as compared to services such as seismic, drilling, wireline and cementing. This production-focused spending could provide some cushion for companies such as Baker Hughes and Halliburton (NYSE:HAL), both of whom derive about 60% of annual revenues from production and completion services. That said, we do expect companies to face pricing pressures (cuts upwards of 15% to 20% are possible) owing to the tough market conditions.

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1. North America Rig Count, Baker Hughes [↩]