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Crude oil rig count drop slows as oil prices start to rebound

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WTI crude oil prices and rig counts

Although the current rig count indicates a production lag, it’s important to keep in mind that the number of active oil rigs loosely follows prices. Oil producers tend to only increase the number of rigs drilling if crude oil prices make production profitable.

When prices increase, rig additions may accelerate. When prices fall, rig additions may slow down. For the number of oil rigs to fall or show a clear downward trend, crude oil prices need to fall to levels that make drilling unprofitable. Although this rarely happens, it does occur, as demonstrated by the trend following the 2008 financial crisis.

This scenario is happening again, as we’ve seen crude prices cut in half over the last eight months. For more on this topic, please read Market Realist’s Why 2008 crude oil prices, rigs’ fall resemble 2014 scenario.

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Crude oil rig count slump slows as energy prices rebound

Between October 10, 2014, and March 6, 2015, the number of active crude oil rigs dropped by 687 to 922, down 43% from peak activity. The collapse in West Texas Intermediate (or WTI) crude prices caused the sharp reduction. WTI crude dropped to ~$49 per barrel on March 6 from levels close to ~$107 in June. Since January 29, 2015, crude oil prices recovered by ~11%.

This week alone, the oil rig count dropped by 64, or 6%. Meanwhile, the WTI oil price remained almost unchanged during the week. Natural gas prices increased ~4% last week.

US upstream companies that produce oil such as Continental Resources (CLR) and Hess Corporation (HES) could see lower revenues as a result of reduced drilling. Plus, these producers could suffer reduced profitability if WTI prices weaken more in the long term. Reduced activity and falling prices can depress oilfield service companies, including Halliburton (HAL) and Baker Hughes (BHI).

Some of these companies are part of the Vanguard Energy ETF (VDE) and the SPDR S&P 500 ETF Trust (SPY). Hess makes up 1.3% of VDE, and Halliburton and Baker Hughes account for ~0.3% of SPY.

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A two-way street

It’s important to note that in the long term, increased rig counts can cause prices to decrease. More rigs result in increased oil production, and increased supply suppresses prices.

In the above chart, you can see that the number of oil-targeted rigs increased approximately fourfold from 2009 to 2014. The associated increase in US oil production helped push crude prices lower. In the past four months, however, the rig count started to fall, following the suppressed crude oil prices.

While this may lead to oil production falling off from its current high, investors should note that the rigs being shut down are the oldest and least sufficient. In the short run, the tight oil production growth from the more productive resource shales should largely offset any effect of rig count slashing.

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