Musings: Is The Rig Count Really 'Falling Off The Cliff?'
We were intrigued to read a Yahoo! Finance headline a week ago Friday that the domestic drilling rig count was "falling off the cliff." The headline was attached to an article discussing the year-end (December 28, 2012) report of the weekly Baker Hughes tally of various drilling rigs working in the oil patch. The article went on to discuss the trends among the various categories of drilling rigs that Baker Hughes reports – oil, gas, other, total, horizontal, directional and vertical. We understand that writers of news articles, especially those posted on news' websites, often become flamboyant with their headlines in order to draw readership. Still, "falling off the cliff" struck us as an over-the-top assessment.
Our first reaction was to examine the rig count data for December and then the last six months of 2012, although we updated everything through the first weekly data point in 2013. We prepared graphs of the two periods just to see visually how this supposed cliff looked. Those graphs are Exhibits 10 and 11 below.
From the week ending November 30, 2012, to the week ending January 4, 2013, the total rig count declined by 48 rigs, or a drop of 2.8 percent. Rigs drilling for oil during this period fell by 68, or a decline of 4.9 percent, while gas-oriented rigs rose by 15, or up 3.5 percent. With crude oil futures prices bouncing from the mid $80s a barrel to the low $90s, one would think there would still be a strong incentive for producers to continue drilling at a healthy rate. What we observed, however, during the latter part of last year was that the logistics for shipping oil to market was disrupting some operations. Additionally, oilfield costs had risen strongly in 2011 and into the first part of 2012 such that many producers were finding they were running out of capital before the end of the year. This was the justification for why so many rigs working in the Bakken area were laid down during the latter part of 2012. That explanation was also supported by the responses to a question posed by the Barclays analysts in their 2013 E&P spending survey in November.
When we examined the rig count over the last half of 2012, we found that the total count fell by 212 rigs, with about three-quarters of them being gas-oriented and one quarter oil-focused rigs. Overall, the rig count declined 10.7 percent during that period, with gas rigs falling by 25.3 percent and oil rigs declining 4.9 percent. Since virtually all the oil-oriented rig decline occurred in the final month of the year, it was more like the fall was due to budgets running out. The gas rig decline, however, reflected further abandonment of dry-gas drilling, which was not unexpected given the lack of a sustained recovery in gas futures prices heading into the winter heating season.
Another chart we prepared (Exhibit 12) covered rig activity from the start of 2007 to the end of 2012. When we visually examined the rig activity trend at the end of 2012 and compared it to the collapse in the fall of 2008 and first half of 2009, which coincided with the financial crisis and start of the global recession that crushed oil and gas prices and created severe cash liquidity issues for many companies, there didn't seem to be any comparison in the patterns. We would describe the late 2008 and early 2009 time period as "falling off the cliff." Just to put that time period into perspective, from mid-September 2008 to mid-March 2009, the total rig count plummeted by 907 rigs, or nearly 45 percent. That was followed by another three months in which the overall rig count dropped another 22 percent. The total rig count fell during this period from 2,019 to 868, or a drop of 1,151 rigs. Oil rigs fell by 56 percent to 183, while gas rigs dropped by 921 rigs to 685. What is very interesting is that from September 2008 to March 2009, oil prices fell from $100 a barrel to $40-45. That certainly would explain the 45 percent rig count drop. But in the next three months when the rig count seemed to be falling at the same rate as in the earlier period, the oil price rebounded to $70 a barrel. The message of this trend is that while commodity prices may be extremely volatile, the oil and gas industry can't respond quite as quickly. Moreover, no one wants to go through a radical downsizing of its business and then jump back in within a matter of weeks – that would have suggested management was only reacting to events rather than managing around them.
So while the Yahoo! Finance headline writer may think the decline in the rig count over the past few months is like going over a cliff, we suggest he should measure activity against the pattern during the financial crisis. That's a pattern we would call "falling off the cliff." Let's hope we never see that magnitude of an industry contraction again, although based on the history of the oil and gas business, it will re-occur sometime.
G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.
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