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Why Rig Count Is No Longer a Reliable Gauge of Production

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It seems that the 'rig count' data have become irrelevant today, especially in terms of oil and gas production.

The figure used to generate considerable excitement among energy investors and has long been deployed to help predict future oil and gas production. However, the correlation seems to come under the spotlight recently.

As per conventional thinking, when number of rigs decline, fewer wells are drilled. This means less new oil and gas are discovered, and ultimately production slows down.

But recent data suggest otherwise.    

Nationwide Oil & Gas Rig Count Slumps

In its latest report, oil services player Baker Hughes, a GE company said that rigs engaged in exploration and production in the U.S. totaled 904 for the week ended Aug 30, 14% less than a year ago.

In particular, the number of oil-directed rigs (at 742) is at its lowest since January 2018. The current total, far from the peak of 1,609 attained in October 2014, is also lower than 862 a year ago.

Meanwhile, the current nationwide natural gas rig count (at 162) has plunged to levels last seen in mid-April 2017. It is well below the previous year’s rig count of 184 and 90% below the all-time high of 1,606 recorded in 2008.  

Moreover, the horizontal/directional rig count (encompassing new technology to drill and extract crude from onshore shale formations) – at 854 – is well below the previous year's tally of 982.

Weakness in Commodity Prices to Blame

There is growing evidence that producers are being repelled by falling crude and natural gas prices. 

As far as oil is concerned, the volatility in realizations have convinced explorers like Apache (APA - Free Report) , Parsley Energy (PE - Free Report) , Equinor (EQNR - Free Report) among others to take a relatively conservative approach on capital expenditure programs. The U.S. crude benchmark, now below $55 a barrel, is also reeling from fears of a global economic slowdown in the backdrop of the U.S.-China trade war. Oil’s troubles pushed the index into a bear market in August, leading to a more than 20% drop from recent highs.

Natural gas, meanwhile, recently fell to levels not seen in more than three years, reflecting a steady, albeit slow, descent. Natural gas might experience short-lived surge based on positive weather forecasts but any powerful turnaround looks unlikely at the moment. With gas output in the lower 48 states recently hitting a record 92.1 Bcf per day, there is little room for prices to improve meaningfully from their current levels of around $2.35 per MMBtu.

Yet Production Hits Record

Per the EIA, the U.S. oil output hit an all-time high of 12.5 million barrels per day last week. Further, the government agency predicts that domestic oil production will average a record 12.3 million barrels per day in 2019.

On the natural gas front, EIA analysis suggests that average domestic supply will climb around 10% year over year to a record high of 91 billion cubic feet per day in 2019. To put things in perspective, U.S. production was averaging around 55 billion cubic feet per day in 2009, only ten years back.

Why the Disparity?

Firstly, producers have become immensely better at churning out oil and gas out of deep underground layers of rock with the help of sophisticated technology.

Secondly, some of the rigs that have been taken out of work were employed in secondary regions where the probability to find oil/gas was low anyway. Therefore, their exclusion did not materially affect overall volumes.

Lastly, 2014’s crude price spike – that saw the commodity breach the $100-a-barrel level – led to massive expansion in domestic drilling. However, the subsequent commodity price crash forced a number of producers to defer the 'fracking' of the wells.

Investors should know that fracking – which follows drilling – is used to complete the well and get the oil flowing. This led to a huge backlog of drilled but uncompleted wells that are now being completed. In other words, lack of new drilling (or lower number of rigs) could still increase production if the wells are being completed.

So, Are Rig Counts Totally Irrelevant?

It’s quite clear that the number of rigs is no longer the sole criteria in determining production movement, as it doesn’t give the whole picture. Consequently, the decline in the number of U.S. drilling rigs has not translated into slowing shale production yet.

For the real picture, one should also take into account existing and impending cut in fracking (or shale drilling) operations from the likes of oilfield services giants Halliburton (HAL - Free Report) and Schlumberger (SLB - Free Report) – both carrying Zacks Rank #3 (Hold) – and spending cuts by top energy companies.

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