The must-know relationship between oil rigs and crude prices

Alex Chamberlin - Author

Dec. 4 2020, Updated 10:52 a.m. ET

Natural gas prices and rigs

The previous parts of this series (parts 8 and 9) explained the counterintuitive relationship between low natural gas prices, falling rigs, and rising natural gas production.

Oil rigs have a simpler relationship with crude oil prices and oil production.

WTI crude prices and oil rigs

The number of rigs in play will loosely follow prices with a lag. Oil producers keep increasing the number of rigs that are drilling for oil as long crude oil prices make production profitable.

As prices increase, rig additions may accelerate. When prices fall, rig additions may slow.

However, for the number of rigs to fall or go into a clear downward trend, crude oil prices would need to fall to levels that make drilling for oil unprofitable. This is a rare occurrence. We saw this happen after the 2008 crisis.

During “ordinary” periods, the general upward trend in rigs should remain intact. There can be intermittent bumps that will loosely reflect substantial changes in oil prices.

For the week ended August 22, oil-targeted rig counts suddenly declined by 25. The drop was likely caused by the recent drop in West Texas Intermediate (or WTI) crude prices. WTI crude had dropped to near ~$92 then from levels close to ~$107 in June.

But this week, oil rigs recovered towards the long-term upward trend. Over the past week, WTI crude prices have also recovered to levels close to $96.

A two-way street

It’s important to note that in the long term, increasing rig counts can cause prices to decrease. This happens because more rigs increase oil production. The increased supply will help control prices.

In the above chart, you can see that the number of oil-targeted rigs increased approximately eightfold from 2009 and 2014. The associated increase in U.S. oil production has pushed WTI prices lower compared to the international benchmark—Brent.

To know learn about the recent oil price trends and increased U.S. production, read our series Must-know: What’s up with crude oil prices?

Key stocks and ETFs

U.S. upstream companies that produce oil—like ConocoPhillips (COP) and Hess Corporation (HES)—could see higher revenues as a result of increased drilling and oil production in the near term. They could also suffer from reduced profitability if WTI prices weaken more in the long term.

A better way to play the rising rig trend would be oilfield service companies like Halliburton (HAL) and Schlumberger Ltd. (SLB). These companies would be insulated more from short-term swings in oil prices compared to the upstream companies listed above.

Some of the companies we discussed above are components of the Energy Select Sector SPDR (XLE). XLE is an even better way to gain diversified exposure to the oil and gas exploration and production industry.

Check out our Energy & Power sector page for more interesting articles on the industry. Learn what’s been happening lately in the sector.

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