While the decline in the drilling rig count continues, the puzzling issue is the continued increase in domestic oil output, G. Allen Brooks says.
This opinion piece presents the opinions of the author.
Are you confused about oil price volatility? Is your neck sore from being snapped around by sudden changes in what’s now the most important industry data point for determining the near-term course of oil prices? Are you numb from listening to the instant experts on the cable news channels? Maybe you’ve decided to chuck it all in and go on vacation. Not a bad idea!
Watching weekly data points is often a worthless effort since so many of them are either compete estimates, admittedly prepared by knowledgeable people, or hybrid guestimates based on partial data supplemented with estimates for missing data points. Throughout our career we have been subjected to having to focus on the data-point du jour or du week. They ranged from daily oil price movements and weekly drilling rig count changes to weekly storage estimates for crude oil and natural gas and oil import and domestic oil production volumes. People are mostly focused on the U.S. oil business but that is just one part of the domestic energy business and a small piece of the global energy industry. In this country, our industry is made up of hundreds of oil companies and individuals ranging from sole proprietorships to multi-billion dollar global enterprises. With thousands of rigs drilling tens of thousands of wells and hundreds of thousands of producing wells spewing out millions of barrels of oil and thousands of cubic feet of natural gas, and huge storage tanks and salt caverns for oil and gas inventories scattered all around the nation, expecting 100% accurate weekly data is foolish, but the quality of the information we receive is quite good, which speaks well of those compiling the reports. A great problem for oil industry observers is that the U.S. produces the best industry data, while much of the rest of the world’s industry lacks transparency. In fact, much of it is opaque.
The Baker Hughes (BHI-NYSE) weekly drilling rig count continues to decline. There are many ways of looking at the information reported and attempting to judge what it all means for future domestic production, but sometimes the simplest approaches are the best. If we examine the change in the weekly rig data based on the types of wells being drilled since the peak in the overall rig count in November 2014, we created the chart below.
Exhibit 1. Latest Weekly Trends Are Becoming Confusing, Source: Baker Hughes, PPHB
Since the week ending November 26, 2014, the total rig count has dropped by 1,058 rigs for a 55% decline. As would be expected by the sheer number of rigs drilling horizontal wells, that category fell by 708 rigs producing a 52% decline. The vertical rig count fell by 101 rigs, but that represented a 71% drop, which reflects how the shale revolution altered the types of wells drilled.
Exhibit 2. The Current Rig Downturn Matching 2008-2009, Source: Baker Hughes, PPHB
While rigs are falling, having dropped by nine last week, the question becomes: When will the bleeding stop? Compared with the 2008-2009 oil market crash due to the financial crisis and recession, which is the benchmark most are comparing this correction against, it seems like we are approaching the end of the decline.
While the decline in the drilling rig count continues, albeit at a much slower pace than experienced several months ago, the puzzling issue is the continued increase in domestic oil output. The reason these weekly production estimates show increases is the belief that the tight oil industry has continued to improve its drilling efficiency by targeting the most productive portions of formations and completing wells in ways to maximize output. As we go forward, we will eventually obtain more accurate data for past periods that will either support the assumptions used in the weekly estimates or show them to have been overly optimistic. If the latter scenario unfolds, data revisions will force rethinking about the course of future oil prices, and the change will be quick.
Exhibit 3. Latest Rig Count And Oil Output Data Are Clashing, Source: EIA, Baker Hughes, PPHB
In order to avoid the volatility of weekly data, we opt to track the trend using a 4-week average of oil production. We have plotted oil volumes for the Lower 48 states against the weekly land drilling rig count. We show the peak oil price in June 2014 and peak oil rig activity in October 2014. After nearly 14 months of weekly average production gains since the last decline experienced in early 2014, production fell in April. After a month of weekly declines, we then experienced two weeks of very small increases. Since it is a 4-week average, the April and May production patterns were encouraging, suggesting that the industry had reached a tipping point when production should start falling and at an accelerating rate until more new wells were brought into production. At that point, we had our first weekly oil rig count increase (+2 rigs), which we speculated might have reflected growing confidence among oil producers that better prices were ahead. We then had a huge weekly oil production increase followed by several more weeks of output gains. Those increases seem to have wiped out the optimism for higher oil prices, causing the rig count to resume its fall.
As we said earlier, the weekly data makes determining the future of oil prices and industry fortunes almost impossible. Most of the near-term outlooks are based on people focusing on only one or two data series and then extrapolating recent trends, even if the estimates seem questionable. As much as we are hoping that clarity of the data and the industry’s outlook is at hand, we are not going to raise our hopes very high.
G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.
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