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Morgan Stanley Warns That Rising Rig Count Could Undo The Rally

Shale Oil Tower

In an industry where anything could happen, surprises—often unwelcomed—are hard to come by. Oil is exactly such an industry at the moment. No one is sure where oil is heading, near-tem forecasts range from $20 to $80 per barrel by the end of the year, and there are just too many wild cards on the scene.

So, in a sense, the news that shale producers are launching more drilling rigs is not really news at all. It was expected, the companies themselves said they are ready to start ramping-up production as soon as prices reach some more reasonable level. What’s new, perhaps, is Morgan Stanley’s warning that production from the new wells being drilled could prompt a reversal of forecasts that U.S. crude production is falling and will continue to fall.

Morgan Stanley commodity strategist Adam Longson, who led the team that researched the situation, said that this reversal carries a downside risk for oil prices. According to Longson’s team, “The rig count in the highest initial production counties of the Permian Midland continues to march higher and is not far from its 2015 peak.” That’s impressive on its own, but the other thing that’s new is where all these new rigs are concentrated: in high-yield fields. This means that the ramp-up could be pretty significant.

As Forbes author Art Berman wittily notes, rigs don’t produce oil, wells produce oil. What’s more, even a decline in the rig count does not necessarily signal a respective decline in output. On the contrary, as a Baker Hughes figure shows, while rigs have been in steady and sharp decline since 2014, the number of wells continued to climb throughout the period to February 2016. Related: Shrinking Chinese Demand About To Slam Oil Prices

Things may have stalled for a bit after prices tanked below $30, but now that they have recovered, shale boomers are eager to start pumping more. And prices, of course, reacted to drop well below that dream price level of $50. It wasn’t just the rig count that drove them down; to be fair, Brexit had a central role, but that doesn’t negate the effect of the higher rig count.

Oil producers in the shale patch are aware that they are walking a very fine line. Yet, they don’t really have a lot of options. Talk about rising drilling efficiency and official data that supports it doesn’t pay down debt, and this is what shale boomers have in abundance.

What they don’t have is space for maneuvering as lenders tighten credit. Basically, they can’t continue to curb production, but they must be very careful by how much they increase it. It’s a precarious situation. All that shale boomers can do is continue to work on efficiency and hope that the Brexit fallout subsides quickly.

By Irina Slav for Oilprice.com

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  • Bill Paterson on July 08 2016 said:
    So total rig count from North America goes from 698 on 1-1-16 to 404 on 5-27-16 and we're suppose to believe that the 27 rigs added in the last 45 days is going to turn around NA production. You've got to be kidding me!
  • GREGORY FOREMAN on July 08 2016 said:
    A better “tell” than the increase in drilling rigs is the activity surrounding the 3900 DUC’s, drilled but uncompleted wells. Only one drilling rig in ten will hit a productive formation as opposed to the 3900 horizontal wells already drilled and waiting for fracking and completion. This is a metric or “tell” far more critical to US domestic production than the increase in drilling activity. After all, less than one in ten drilling rigs will hit “pay dirt” whereas the DUC’s have proven production capability but are waiting for the dollars and cents to be brought into production.
    Of course, the next question is will such production be for US consumption or be exported overseas. Owing to the sizeable investments in the more prominent, production fields, ex, Eagle Ford, by the Chinese and Japanese, coupled with the lifting of the US prohibition against crude oil imports, one can only wonder.

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