Oil Prices and Rig Count

Oil  Prices and Rig Count

At what price do drillers add/reduce oil rigs this time? If one looks closely one can see a 2mo lag before drillers ($XOP) ($IEO) cut back on rigs in response to collapse of oil ($USO) ($OIL) prices. Due to the normal volatility in prices one can understand that an immediate response to oil price fluctuations are not reflected in rig activity. It takes at least some period of lower prices before the decision is made to lower rig activity due to uneconomical pricing. Add to this the fact that a drill rig requires a specific series of steps to shut it down and it may prove economically sound to continue drilling even for another few days to use supplies already committed. One can understand the ~2mo delay in the chart below between a sharp fall-off in oil prices and the subsequent cut back in the rig count. It appears that the rig count began to fall only in late Nov 2014 as WTI prices fell below $90bbl.

Screen Shot 2015-05-26 at 11.12.18 AM Rig Count
Rig Count

Even though each well carries its own price at which it is economical, somewhere below $95-$90bbl became this cycle’s economic decision point. It is also clear that drilling activity only resumes more than 6mos after a decent recovery in price. All of this information is reflected in the rig count vs price level history below.

 

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We have already witnessed a WTI price rise of ~35% from the low of ~$45bbl to $61bbl today yet rig counts continue to fall. One can only estimate at what WTI price level drilling will resume. My guess remains ~$85-$90bbl, but only time will tell. Oil drilling/production requires an enormous financial commitment. Drillers require both an economical price and the belief that prices will remain economically favorable for a long enough period to resume activity, i.e. the decision to drill is part economic and part market psychology.

 

US oil production will slow as fracked well production typically carries a sharp fall-off in the 1stproduction year. Even so, it is likely that before we see resumption of activity we will need a WTI price back in the range ~$85-$90bbl range.

 

A educated guesstimate is all anyone is permitted when dealing with investments and economics.

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Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a RealMoney.com contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.