With global oil production falling and demand growth still quite impressive, the overall picture for oil is quite positive in my mind. This comes even as some investors fear that growth will weaken toward the end of 2016 (and it might) and as uncertainty over supplies from conflict-stricken nations has struck a bearish tone for investors in this space. While these indicators are speculative in nature and only time will tell what transpires, the one bearish case being made that can be measured definitively is the rig count, which has been rising in the U.S. recently.
Given this trend, with the oil rig count up five of the past six weeks and the natural gas rig count being a bit more mixed (with a total increase of only one rig over the prior six weeks), an argument could be made that higher prices have pushed producers into action and this could put pressure on the oil price recovery. Although this warrants consideration from investors in this space, what's interesting is that the recent uptick in the rig count appears to be a U.S. phenomenon, not a global one. In what follows, I will discuss the data I've seen and give my own thoughts on what it should mean for investors in companies like Memorial Production Partners (NASDAQ:MEMP), Approach Resources (NASDAQ:AREX), and Legacy Reserves (NASDAQ:LGCY), as well as for those in the United States Oil ETF (NYSEARCA:USO) and other oil-related ETFs.
The U.S. Rig Count is Rising
There's no denying, thanks to Baker Hughes (NYSE:BHI), that the U.S. oil rig count has been rising and a big contributor to this increase has been the Permian Basin, which houses some of the cheapest drilling costs in the country, but also some of the most expensive. Between May 27th of this year and July 8th, for instance, the oil rig count has grown by 35 units from 316 to 351. Of this increase, 21 rigs have come from the Permian, which has seen its rig count increase from 137 units to 158 while places like the Eagle Ford, Williston, and Niobrara, have seen their rig counts tick up as little as 1 unit to as many as 6.
In the past, I covered the advantages and drawbacks to the rig count changing more in the Permian than it is elsewhere and I encourage investors to read that piece. However, increases, if they become meaningful in places like the Eagle Ford, Williston, and Niobrara, could be trouble down the line if nothing else changes, so I'm evaluating the situation in these regions closely. What's more is the fact that, even with these increases, the rig count picture is still far better than it was a year ago, with the oil rig count down 45.6% from 645 units, and the overall rig count down 49% from 863 units.
The Picture Looks Different Outside of the U.S.
Absent coordination from OPEC and maybe some non-OPEC nations in the future (which I believe will come at some point in time), it's looking a lot like the U.S. will become the world's swing producer down the road. This means that the change in the rig count here (adjusting for productivity increases, changes in demand, supply disruptions, etc...) will be the single largest determinant of the course that oil will take. Because of this, it cannot be denied that the oil rig count and basin composition in the U.S. is of the utmost importance, but it's also imperative to be cognizant of the fact that changes outside of the U.S. will have an impact on oil production and, ultimately, prices down the road.
It is because of this significance that other regions of the world play that I posted the table above. In it, you can see the month-to-month change in the total rig count (the data isn't broken up in it by oil or natural gas unfortunately) in not only the U.S. but also in Canada, the Middle East, Asia/Pacific, Africa, Europe and Latin America. In the table below, you can see last year's complete table and the table from the year before, so we have something to compare this year's data to.
What's interesting here is that the rig count, on a month-to-month basis, has risen in only the U.S. and Canada. By looking at the trend in Canada, this shouldn't be surprising since June has usually seen a sizable uptick in drilling activity over this timeframe. This doesn't bother me at all and makes me really only worry over the U.S. Outside of these two countries, though, the rig count is down, especially in Latin America, where the rig count has dropped by 10 units from May to June. Last year, the count there was a whopping 314 units, making it one of the most-severely impacted regions in the world. Elsewhere, the trend is the same but the severity of the trend isn't as bad.
Unfortunately, it's difficult to tell the full impact that this all will have on the global oil and natural gas market because data for these regions regarding decline rates and rig productivity improvement rates can be hard, if not impossible, to come by. However, what is certain is that you can't see the rig count fall materially and expect for production to stay high down the road. At this moment, the total global rig count is down 729 units year-over-year and down an astounding 2,038 units compared to June of 2014.
On a month-to-month basis, the global rig count is only up by 2 units from 1,405 to 1,407 and it appears as though this number will probably rise in July thanks to the U.S. and Canada. When you look at the situation from this perspective, it's not hard to tell why investors are somewhat concerned by the recent uptick in drilling activity in the U.S. but when you aggregate the data across the globe, the picture looks far less bearish. Does this mean that oil prices will rise or sink in the near-term? I don't know and neither does anybody else. What I do know, though, is that such a minuscule increase in the global rig count should have virtually no material impact on the picture down the road. Only in the event that we see a resurgence in the global rig count as a whole should investors be worried about the impact moving forward.
Disclosure: I am/we are long AREX, MEMP, LGCY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own LGCYO, not LGCY
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.