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Does A Rising Rig Count Signal The End Of The Oil Rally?

Oil Rigs

The U.S. rig count jumped for the second consecutive week last week, as oil and gas companies start to get back to work as oil prices hit $50 per barrel.

The industry added 3 additional oil rigs and 3 gas rigs for the week ending on June 10, according to Baker Hughes. The increase seemed to spook oil prices as WTI and Brent retreated on Friday following the data release, dipping back below $50 per barrel. The strengthening of the U.S. dollar also weighed on oil prices.

"Today's oil rig count could exert a price impact with any increase," Jim Ritterbusch of oil markets consultancy Ritterbusch & Associates, told Reuters.

As evidence that shale drillers could kill off the price rally by restarting drilling, Harold Hamm, CEO of Continental Resources, has announced his intentions to begin completing some drilled but uncompleted wells (DUCs) again with oil prices up to $50. Hamm says he thinks oil will rise to $70 per barrel before the end of the year as global oil markets dipped into a supply deficit in the second quarter, in large part because of major outages in Nigeria and Canada, but also because U.S. production is down 900,000 barrels per day from the April 2015 peak. But the markets see Hamm’s decision to begin completing wells as a bearish indicator – the rebound in oil prices could trigger new supplies. The rise in the rig count over the past two weeks has only added to that sentiment.

Moreover, oil price pessimists have pointed to the fact that the declines in U.S. oil production, which have been consistent throughout 2016 so far, have seemed to slowed and maybe even halted. Last week the EIA reported that the U.S. added 10,000 barrels per day to overall production, the first increase in months. Related: Utah Oil Sands Set For A Bright And Clean Future

It seems, then, that the oil price rally is in danger of ending.

While further price gains are certainly far from assured, the concern about U.S. production suddenly rebounding is overblown. First of all, last week’s production increase is misleading – the increase came because of an 18,000 barrel per day uptick in production from Alaska. The Lower 48 still lost 10,000 barrels per day. The increase could be an anomaly.

Also, concerns about a rising rig count is similarly overstated. There have been just 12 rigs added back to the oil patch after months of declines, and the overall rig count is still near all-time lows. In the second half of 2014, when drilling was at a peak, there were more than 1,600 oil rigs in the field. Now there are only 328.

Furthermore, even if many more rigs come back into service, it will take time before production comes online. “I think people really underappreciate the time it’s going to take to not only put rigs back to work but get completion crews to actually complete the process and bring the wells back online. Sure you are going to get some incremental pick-ups here and there…but more or less lead times are upwards of two to three months. So I don’t really think it’s going to be a material increase anytime soon,” Andrew Cosgrove, an oil analyst at Bloomberg Intelligence, said on June 10. Related: Oil Supply Disruptions Highest In Five Years

Also, even if drillers have figured out ways to become more efficient, cut costs and increase rig productivity, there won’t be a flood of new oil coming online. Any uptick in production will likely continue to be outweighed by the very large volumes of legacy production that continues to deplete. “You are going to need less rigs to generate the same amount of production that we saw back in 2014. So the rig count is kind of going to be somewhat of a misleading indicator on production trends. But I don’t really think U.S. production can really ramp up and return to growth until the second half of 2017.”

There will be individual companies that add new rigs to the field and begin drilling again. But it is highly unlikely that a tidal wave of new production will come back online.

By Nick Cunningham of Oilprice.com

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  • Karthik Srinivasan on June 14 2016 said:
    According to Genscape, while there are 3000-3500 total DUCs in the US, if you strip out the 1000 DUCs that persistently remain in inventory (ie. due to pad drilling), there are only 2000-2500 DUCs out there that represent abnormal inventory. Of that number, at least 1/4 are likely in the Bakken, which will require persistently higher prices. Moreover, at least 1000 DUCs are in low quality areas that will require prices above $80 to justify completing (given 60-70% of a well's cost is related to completion). Thus, the inventory overhang is likely dramatically overstated particularly in the context of depletion rates of new shale wells in the range of 20-40% in their first year (assuming some level of choking to manage production).
  • Michael DiCroce on August 05 2016 said:
    Oil companies are starting to anticipate higher prices in the future. This is extremely bullish. Short term things could go lower, but long term producers would not bring more oil to market unless it is more valuable then leaving it in the ground.

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