The past two weeks have been challenging for the oil market. During this timeframe, the oil rig count in the U.S. has risen by 12 units, climbing from 316 units to 328. For investors in this space, this is scary since the fear is that rising prices will eventually lead to more drilling, which would only serve to delay the oil market recovery. In what follows, I will dig into what is happening with the oil rig count and discuss what it means for 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.
A look at where the rig count change is coming from
Anybody who has been following the Baker Hughes (BHI) rig count for any meaningful period of time knows that the overall change in it over the past year or so has been tremendous. At this moment, the oil rig count stands at 328 units but exactly a year earlier that number was estimated to be 635 units, representing a year-over-year decline of 48.3%. Looking all the way back to October 10th of 2014, the rig decline has been even more severe. During this timeframe, the count is down by 79.6% from the 1,609 units seen operating back then.
Recently, despite the major increase in oil prices, some areas have seen the rig count either level off or continue to fall gradually, as you can see in the graph below. Based on the data provided, since April 29th of this year, the rig count in the Niobrara has dipped from 14 units to the 12 seen operating today. Meanwhile, in the Eagle Ford, the unit count has fallen from 31 units in operation to 26 but the rise in oil prices appears to have halted the decline for now, with the rig count staying flat at that level over the past three weeks. Unfortunately, Baker Hughes does not provide consolidated data for the Bakken specifically but the closest comparable to that in their report is the Williston Basin. Over the past week, the oil rig count there did increase by two units but it's still lower than the 26 units seen in operation at the end of April.
The largest area of rig count increase lately has come from the Permian Basin. At the end of April, the count stood at 132 units, the lowest seen in several years and 76.5% lower than the 562 units seen in October of 2014. Today, that number stands at 142 units, meaning that the uptick in drilling in the area is meaningful. Part of this is due to the fact that the Permian has very low decline rates compared to other regions, but it's also due to the fact that, in the Delaware portion of the basin, at least, drilling costs are low (though the Midland portion is among the most expensive regions in the U.S. in which to drill).
What's this mean for production?
Overall, it's hard to tell what an increase in output from the Permian means because data from the area changes every month. Using the most recent data provided by the EIA in its monthly Drilling Productivity Report, each additional rig in operation should be responsible for the production of about 493 barrels per day in extra crude. Since the rig count in the area began to increase, this means that an added 4,930 barrels of crude per day should be released onto the market.
Thankfully, this isn't a big deal but it could become one if the rig count continues its ascent. Compared to the other big regions in the country, though, this uptick isn't all that important for now. Take, for instance, the Eagle Ford, which produces around 994 barrels per day for every rig in operation. The 5 rigs there that have been taken offline over the past seven weeks should, with 4,970 barrels per day coming offline, more than offset the uptick seen in the Permian. The 915 barrels per day seen in the Niobrara should result in another 1,830 barrels per day coming offline, while the Bakken (using the Williston's rig count but the Bakken's productivity) should see another 1,664 barrels per day come offline with extra output of 832 rigs per day in the region.
Of course, just leaving the analysis at this would be a mistake for two reasons. First is the fact that, of these regions, the Permian has the highest productivity increase from month-to-month at about 3%. Second is the fact that the decline rate in each region varies. The Permian decline rate is about 4% each month right now, compared to 5% for the Bakken, 8% for the Niobrara and 8.25% for the Eagle Ford. In the table above, I've provided an analysis, taking into consideration all of these factors, what the picture should look like in 12 months from June had the rig count remained unchanged from where it was at the end of April. Meanwhile, in the table below, I've decided to use the current rig count estimates to do the exact same analysis to see how the change in the rig count over this timeframe (namely the uptick in the Permian combined with decreases elsewhere) should impact the supply/demand picture in the U.S.
Using this data, I was able to create the following table below. In it, you can see the disparity created by the increase in the rig count in the Permian and the decrease in the rig count in the Eagle Ford, Niobrara, and Williston/Bakken 12 months out. Based on the data provided, even with an increase in activity in the Permian, production next June, keeping all else the same, would still be 18,999 barrels per day below where estimates placed it back before the Permian rig count began to climb.
At this moment, Mr. Market is worried about what's happening with the rig count and it is certainly bad to see any increase in drilling activity while inventory levels are as high as they are. Having said that, even with the increase in production from the Permian, the declines taking place elsewhere should more than offset this. Of course, if the rig count continues to rise there and it remains unchanged in these other regions or even begins to increase again, there could be trouble and investors should keep an eye out for these things happening but, for now, that doesn't seem to be a significant threat.
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: My LGCY position is in the form of preferred units, not common ones.
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