Where Is The U.S. Oil Rig Count Headed?

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Baker Hughes (NYSE:BHI) published its weekly North American rig count on Friday, indicating that the U.S. oil rig count fell by 7 over the last week to 635 rigs, marking the 27th straight week of declines. The oil rig count is down by over 60% from its peak of 1,609 last October and is down by over 55% year-to-date. The rig count has been a closely watched metric in the crude oil markets over the last few quarters, as investors and traders try to gain a sense of direction in prices by examining supply side factors in the U.S. land drilling markets. We believe that the U.S. oil rig count could continue to face some pressure due to a challenging near-term outlook for crude oil prices and also due to efficiency improvements in the industry. That said, the rate of the decline will likely be more moderate. Here’s a quick look at some of the trends which could influence the U.S. oil rig count.

Near-Term Oil Prices Could And Growing Rig Efficiency

We believe that crude oil prices will remain capped in the near-term. While WTI crude has been trading at a narrow range of about $60/barrel over the last few weeks, prices are off their early 2015 lows, owing partly to lower upstream investments and news of sequential month-over-month declines in production from seven of the most prolific shale oil fields in the United States. That said, oil output will still be higher on a year-over-year basis and if we factor in additional supply growth from other non-OPEC regions, the gap between global supply and demand is not expected to shrink significantly in the near-term (related: Oil Prices To Remain Capped In The Short Term, Despite Fewer Shale Oil Barrels). Since most tight-oil players are estimated to have break-even-costs of more than $65/barrel, it’s unlikely that they will want to deploy more rigs in the current environment.

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Extracting crude oil from shale formations has also become so much more efficient over the past few years, driven by continued efficiency improvements in drilling techniques and the increased adoption of multi-well pad drilling. For instance, crude oil production per active rig from the seven key regions in the Lower 48 states has surged to more than 8x the average level in 2007, meaning that fewer rigs will be required to maintain a given level of output. For example, EOG Resources (NYSE:EOG), one of the pioneers in the U.S. shale oil industry, has been able to reduce the average drilling time per well in the Eagle Ford shale from over 22 days in 2011 to less than 10 days currently.

Why The Rate Of The Decline Could Slow Down 

We believe that the U.S. oil rig count could continue its descent in the near-term, although the rate of the decline is likely to be more moderate, given that operators will need rigs to maintain a base level of production. Tight oil wells typically see their output peak off quickly, requiring operators to drill new wells to maintain production. Separately, tight oil drillers can respond to an increase in oil prices much more quickly when compared to conventional players, since they can typically drill, complete and begin production from a new well in the span of a few weeks. If oil prices were to increase significantly for any reason, the U.S. rig count could rise relatively quickly.

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