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Peter Tertzakian

Peter Tertzakian

Peter is an economist, investment strategist, author and public speaker on issues vital to the future of energy. He has clocked over 30 years of…

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Forget Inventories – Drilling Cutbacks Will Lead To Much Higher Oil Prices


Oil markets continue to debate the vagaries of how much crude and refined products are stored in big white tanks and floating carriers. The feeling is that there is too much sloshing around. That’s why the oil price is under siege again, down 10 percent in the past three weeks.

Meanwhile, the untold story is at the front end of the supply chain. The iron equipment that works to put oil into storage vessels is going idle the world over. Every week, an increasing number of drilling rigs are hosting weeds and barnacles. That’s of concern, because fixating on inventories for any product is a narrow thought process. Think of it this way: There are no worries when there is plenty of food in the fridge; but unease about the future sets in when farmers stop planting their crops.

Our feature chart this week shows 20+ years of active drilling rig data (oil targeted) from Baker Hughes. Five regions outside North America are profiled: Latin America; the Middle East; Europe; Asia and Africa. Both offshore and onshore rigs are included.

Except for the Middle East, the number of active rigs in every region has retreated to mid-2000 levels. But oil consumption is going the other way; compared to 10 years ago the world burns over 10 million more barrels a day of the vital commodity.

Oil producers began slashing their exploration programs in January 2015, over 18 months ago. Back then there were 982 spinning drill bits outside Canada and the United States. Now there are only 677, a drop over 30 percent. And the number will go lower yet.

(Click to enlarge)

Latin America has seen the biggest retreat in the international grouping. Rig counts in Brazil, Colombia and Mexico are all down by over two-thirds, Argentina by 40 percent. High costs, bureaucracy and political issues are all exacerbating the impact of low prices. This is déjà vu: Our chart shows that Latin American producers also suffered hard during the 1998 downturn. Related: The Biggest Threat To Oil Prices Is The Dollar, Not A Supply Glut

Oil drilling in the Asia-Pacific region is off by 22 percent since January 2015. There are a lot of countries in this group, but the meaningful rig counts are mostly in China and India. Although the downtrend is choppy, the count has popped up by about 10 rigs lately. But it’s hardly a recovery. Recent commodity price weakness will make the gravity pull harder.

African and European activity trends are very similar in size and character. Europe is mostly offshore North Sea. Africa has some onshore, but a lot of offshore too, especially off the west coast. Activity in both regions fell abruptly in the first half of 2015, then started to taper off a year ago. Further spending neglect is inevitable in both Europe and Africa.

Middle Eastern exploration activity has eased off the least, given the region’s low cost and ambition to fight a global price war. A big jump in rigs back in 2012 is attributable to Iraq’s return to the market. Rig counts in Saudi Arabia are still holding steady, as the Kingdom continues to tap into plentiful reserves. But the overall trend in this prolific region is still down as a dearth of capital squeezes exploration spending like everywhere else. Related: Is This The Beginning Of The End For Venezuela's Oil Sector?

And what about North America? The market is fixated on the U.S. oil rig count, which has crept up by over 50 rigs since the price of WTI oil popped its head above $45/B. But 50 is not much; considering that 75% of the 1,500 rigs working at the start of 2015 are still parked – an even greater decline than in Latin America. So, is it realistic to think that a handful of U.S. drilling rigs going back to work can offset universally declining activity elsewhere in the world?

It’s unlikely. Admittedly, rig productivity is considerably better today than in 2015 – each working rig can deliver more oil to market. Prolific U.S. oilfields like the Permian in Texas have been impressive in their ability to deliver large quantities of oil with new processes and technology. But over 85 percent of the world’s oil production is outside the United States and productivity hasn’t improved enough in 18 months to offset the rapid fall in upstream spending and activity.

Global producers are broadly divesting of exploration activity at the same time as consumers are investing in 90 million new hydrocarbon-consuming vehicles each year. Inventories may be full for now, but nothing in the global drilling data is comforting about future oil supply meeting still-growing consumption.

By Peter Tertzakian for Oilprice.com

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Leave a comment
  • JP DeCaen on July 28 2016 said:
    When is the author suggesting that a shortage will take place? It might be a while considering the surplus of both crude and refined products. A high price returning would likely result in permanent demand destruction, as Art Berman points out in his recent article. The bubble would be short lived. Also: the price needs to be quite a bit higher for the E and P's just to pay off all their debts, so a higher price doesn't necessarily spell big profits.
  • Merc on July 29 2016 said:
    It is reassuring to see someone taking the longer view. So much of the pessimism is about supply...

    I hope you are right, as I am long in oil across much of my portfolio.
  • Dex on July 29 2016 said:
    Definitely, this guy is holding long position from $45.
  • John Brown on July 29 2016 said:
    Here we go again. There is a glut of oil sloshing around the world and its been there all year. Oil is being stored at sea in tankers that should be delivering it not storing it, and the same with rail cars. Finally the price of oil is dropping back down based on the reality of over supply and slowing demand. The USA has lousy 1.2% growth in Q2, and China is propping itself up with DEBT, and still if its doubtful if its actually growing at all.
    So now with the glut obvious and prices falling back toward $30 a barrel we get these stories about cut backs in production to prop up the price. More supply is coming online folks, not less, and what nobody seems to get is that due to improvements in technology and cost production can come back much faster than ever before in history. At this point there is no reason for a barrel of oil to be above $30 a barrel, and nothing real over the next 2 years shows that there's much of a reason for it to go up, and any spike in the price will pretty quickly result in more supply.
  • EH on August 02 2016 said:
    What a delusional idiot, the consumer isn't. Hey, anyone remember "Alfred E. Newman"@ the podium about about 2 decade ago after fuel shot from $1.19 to $3.44 a gal and consumers were looking for relief from,, haha, leadership? Remember GW's reply? Supply and demand. Go ahead, raise the price and while you're at it go ahead and shoot yourself in the foot too.

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