Recent Trends In The U.S. Oil Rig Count And Where It Could Be Headed

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Baker Hughes (NYSE:BHI) reported that the U.S. oil rig count fell by 37 units last week to 1019 units, marking the lowest levels since July 2011, as drillers continued to lay down rigs in response to a challenging oil pricing environment. The metric, which reflects the number of rigs actively drilling for oil and serves as a broad indicator of oilfield services activity, is down by roughly 31% since the beginning of this year and around 37% from its mid-October 2014 highs. [1] The North American rig count has been a very 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. U.S. benchmark WTI crude is currently trading at levels of around $50 per barrel, down by close to 50% since June 2014. In this note, we take a look at some of the recent trends in the U.S. oil rig count and what to expect from the metric in the near term.

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Lower Horizontal And Vertical Rig Count

Much of the decline in the rig count has come from horizontal rigs, which are used to target unconventional hydrocarbons. The total number of horizontal rigs (oil and gas) in North America has fallen from 1,336 units in the beginning of the year to 979 units, marking a 27% decline year-to-date. The vertical rig count, which is an indicator of activity in conventional plays, is also down from 300 units in early January to 203 units. The magnitude of the decline in the rig count has also varied across basins, owing to different marginal costs of production. While the rig count in the Permian basin, which is one of the most active oil drilling regions in the United States, is down by 31% or roughly in line with the nationwide decline, less developed  (and possibly higher marginal cost) basins such as the DJ-Niobrara have seen the count decline by about 38% year-to-date. The Eagle Ford shale, which has emerged as one of the most prolific and low-cost tight oil plays, has seen its oil rig count decline by about 24%.

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Oil Rig Count Likely To Trend Lower

We believe that the North American rig count could continue its descent in the near-term, although the rate of the decline is likely to be more moderate. Unlike some previous downturns in the oil markets (2008-2009, for instance),  the current pricing environment has been brought about largely by the oversupply of oil rather than by a sharp slowdown in global demand growth. At current levels of drilling and development activity, it’s likely that global production will continue t0 grow, maintaining an overhang in the oil markets. The International Energy Agency (IEA) forecasts global oil demand growth for 2015 to stand at 0.9 million barrels/day, bringing average demand for the year to 93.4 million b/d. [2] OPEC expects its members’ output to rise by rise by 0.4 million b/d this year while the IEA projects 2015 non-OPEC supply growth at roughly 0.8 million b/d. [3] This would mean that supply is likely to stay ahead of demand and the IEA expects prices to average $55/barrel in 2015. ((Oil to remain around $55 this year: IEA, MarketWatch, February 2015)) This is likely to be below the production costs for most tight-oil players in the U.S. market, and it is likely that the shakeout in rig activity will continue over the near-term as more drillers scale back amid weaker cash flows. This trend is also evident from the recent capex cuts (average 20-30%) by most upstream oil and gas players as well as large job cuts by the big three oilfield services firms – Schlumberger (NYSE:SLB), Baker Hughes and Halliburton (NYSE:HAL) – who have announced plans to lay off roughly 7% to 11% of their respective workforces.

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Notes:
  1. North America Rig Count, Baker Hughes []
  2. Oil Market Report, IEA []
  3. The Saudi project, part two, The Economist, February 2015 []