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Crude Oil Prices Steady as Rig Count Slide Slows

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WTI crude oil prices and rig counts

Although the current rig count indicates future production trends with a lag, it’s important to keep in mind that the number of active oil rigs also reacts to prices. Oil producers tend to only increase the number of rigs drilling if expected energy 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.

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This scenario has unfolded again recently, as we’ve seen crude prices cut in half over the last eight months. Between October 10, 2014, and April 2, 2015, the number of active crude oil rigs dropped by 807 to 802, down 50% from peak activity. For more on this topic, read Why 2008 crude oil prices, rigs’ fall resemble 2014 scenario.

US producers affected by oil price

US upstream companies that produce oil such as Continental Resources (CLR) and Hess Corporation (HES) could see lower revenues in the longer term as a result of reduced drilling. Reduced activity and falling prices can also depress oilfield service companies profits, 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). Continental Resources makes up 0.26% 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 six 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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