Must-know: Why crude and natural gas prices drive rig counts

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Crude and natural gas prices drive rig counts

When the worst of the recession hit, U.S. oil rig counts fell from over 400 to nearly 175. They “bottomed-out” around mid-2009 when oil prices sank to below $40 per barrel. No one was wanting to drill for oil because it was unprofitable. Since then oil prices and rig counts have both recovered.Oil Rigs Jan-06 to Jan-14

WTI crude prices

For most of the last two years, West Texas Intermediate (or WTI) crude oil has been range-bound between ~$85 per barrel and ~$110 per barrel. Higher crude prices generally have a positive effect on stocks in the energy sector.

Crude OIl Prices

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Upstream names that produce oil see higher revenues, cash flows, and returns from higher oil prices. This causes upstream oil companies like Whiting Petroleum Corporation (WLL) and Hess Corporation (HES) to invest more money in drilling more oil wells. Higher investments also benefit oilfield service companies.

Natural gas prices

Natural gas prices

Natural gas prices throughout 2014 are still up from last year, with 1H14 prices averaging $4.60 per million British thermal units (or MMBtu) compared to the 2013 average price of $3.73 per MMBtu. However, they’re still lower than historical levels given the strong supplies of gas from the horizontal drilling and hydraulic fracturing-induced shale boom in the U.S.

Currently, natural gas is trading at around ~$3.77 per MMBtu. The price at the beginning of the year was $4.32 per MMBtu, or higher by ~14%, compared to the current level.

However, increasingly higher production and inventory build-up may result in sustained price drops. Low natural gas prices can cause producers to stop drilling for natural gas. The economics of drilling natural gas wells becomes less attractive with lower natural gas prices. Some of the gas-heavy producers in the U.S. include Chesapeake Energy Corporation (CHK) and CONSOL Energy (CNX).

Key exchange-traded fund (or ETF)

Some of the upstream producers discussed above are components of the Energy Select Sector SPDR (XLE).

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