Last Friday, Baker Hughes (BHI-NYSE) reported its weekly U.S. drilling rig count data showing a six-rig increase from the prior week, as well as a six-rig increase in the number of drilling rigs seeking crude oil. These increases have continued for 22 weeks, the longest consecutive streak of weekly rig count gains since 1987. WTI ended last week at $44.74 a barrel, up 28 cents on the day, but down for the fourth consecutive week. Over that span, WTI has fallen by 11%, from $50.33 a barrel. At the same time, the overall rig count increased by 2.8%, but the oil rig count rose 3.5%.
One would have thought that the pessimism for oil prices overtaking the crude oil market following OPEC and its non-OPEC supporters’ agreement to extend their production cuts for another nine months, would have caused explorers to pull back their drilling activity. Libya and Nigeria, both OPEC countries excluded from the production cut quota, have increased their output that, along with non-OPEC producers, has minimized the decline in global oil inventories, from the OPEC production cut. In fact, oil inventories in the 35 countries that make up the Organization for Economic Cooperation and Development (OECD) increased by 18.6 million barrels in April. OPEC points out that OECD oil inventories have fallen during the first four months of 2017, but only by 88 million barrels. At that pace, it will take OPEC and its partners until March 2018 to reduce global oil stocks by another 250 million barrels, or back to the average inventory level of the last five years, the organization’s goal.
At the same time, U.S. oil output continues growing in response to the increase in the number of working drilling rigs. As a result, the International Energy Agency (IEA) is projecting that U.S. oil output will grow by almost 5% on average this year, and by nearly 8% in 2018, overwhelming projected demand growth and re-establishing the glut environment. This forecast is creating concern about the success of OPEC’s strategy of cutting its output. The pessimistic view of crude oil prices rests on the belief that the slow pace in reducing oil inventories will create an environment where cheating on production cuts occurs, making it impossible for demand growth alone to drive oil prices higher. The optimists, including OPEC, believe that its strategy is working, it will merely need more time – hence the nine-month extension rather than a six-month one.
What we know is that the lift in oil prices sparked a drilling rig recovery in 2016, which has continued into 2017, and has become the fastest industry recovery in history. Although the recovery has been the fastest, it has yet to reach the levels of the recoveries of 1979 and 2009. The current weakening of crude oil prices is likely to cut short this rig recovery below the levels reached in those earlier recoveries, unless something else is at work in the oil patch.
Many people are interested in seeing how the current industry downturn and recovery compares to previous ones. To begin to answer this question, we dug into our archives for several charts of rig declines to go along with the chart in Exhibit 1 that shows the performance of various drilling recoveries.
The indexed 2014-2016 rig decline was the sharpest drop ever and was nearly as long as the decline of 1984-1986. What is possibly more interesting, however, is to examine the magnitude of the various rig declines. As shown in Exhibit 3, in the 1981-1983 rig decline the industry lost more working rigs than were operating at the start of the 2014-2016 decline. The same was true for the 1984-1986 decline. This reflects the impact of drilling rig capability and efficiency due to the introduction of new drilling technology, and now, new well completion technology.
One wonders if the current rig recovery will continue with crude oil prices residing in the mid-$40s a barrel due to the improved breakeven prices of shale wells? If that is the case, then OPEC/non-OPEC’s efforts to cut production, reduce the oil supply glut and boost oil prices into the $60s a barrel range will help U.S. shale producers more than OPEC expects. It would certainly suggest that rather than an impending flattening or decline in drilling activity, the rig count could continue to go higher as profitability increases with higher oil prices, helping to make more shale areas economic. If Saudi Arabia works to lift oil prices into the $60s to help support its initial public offering of Saudi Aramco in early 2018, we could see the U.S. rig count rise almost continuously, further transforming the U.S. oil industry into a global market force.
A stronger drilling rig recovery may reflect a significant change underway in America’s oil industry. It certainly supports the IEA’s view of solid oil production growth during the next 18 months, and maybe for even longer. We may be witnessing the rebirth of America’s oil industry dominance on the world stage, but don’t fully appreciate the event.