Split in oil-price, rig-count flows a cause for concern? Not yet.
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In an unusual twist, the growth rate of the U.S. land-based rig count eclipsed the rate of change in the price of West Texas Intermediate (WTI) crude oil last fall.

Typically, the U.S. land rig count mirrors changes in the price of oil by a two- or three-month lag. The relationship between the two over the past four years currently measures 98 percent — meaning only 2 percent of the change in the rig count is not historically explained by coinciding changes in oil prices.  

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Is this current trend a technical indicator signaling the rig count could stall in the coming months, allowing for the strong relationship to realign itself? We asked ourselves — is this a true signal or a false warning light? 

 

Following a low point in May 2016, the U.S. land rig count has responded more favorably to last fall's OPEC/non-OPEC members’ production cut agreement than have WTI crude oil prices — on a percentage basis — which hit their lows in February 2016.

That the land rig count is recovering at a stronger pace than its underlying commodity, which usually is the catalyst for changes in the rig count, does present a reason for concern.

Hence our reasoning that the recent stronger growth rate in U.S. land rigs, relative to WTI crude oil prices, may be a technical indicator that the rig count’s growth could stall in the months ahead for the relationship to realign itself.

Observing recent historical data allows us to contrast the recovery in rig counts from the 2008-2009 downturn to the recent trend. The data show the 2008-2009 rig-count recovery took nine months longer to achieve parity with oil prices than what has transpired in the current cycle — from the third quarter of 2016 to today. Yet, there are mitigating factors that need to be considered for both cycles.

The Federal Reserve instituted quantitative easing measures during the last recession, which yielded a looser monetary stance for the U.S. dollar. Since oil prices are denominated in U.S. currency, the Fed’s deliberate measures to weaken the dollar made oil prices, along with many other commodity prices that are tied to the dollar, move in the opposite direction — higher.

This pattern may help explain the extended period of time required after 2008-2009 for changes in the rig count to catch up with oil-price movements. Additionally, the recent rig count bottomed out with nearly five hundred fewer rigs than the low set in 2008-2009. 

It is much easier to achieve higher rates of change, relative to another time period, if the starting point for measuring the change in units is substantially depressed. Thus, from a growth perspective, the latest cycle’s rig recovery benefits from starting at a lower point than the past recovery.

It is this discrepancy — where each bottom occurred during these two rig-count cycles — that mitigates the climb the U.S. rig count has made relative to what oil prices have recently accomplished.

One other aspect contributing to the difference between the current rig-count/oil-price relationship and that of the prior recovery is interest-rate expectations. The Federal Reserve is signaling it will enact policies that drive interest rates higher, which, in effect, strengthens the outlook for the U.S. dollar. This is the exact opposite scenario of the prior recovery, as previously noted. 

Even though the 2009 and 2016 lows for monthly average oil prices both occurred in February, while both rig-count lows occurred in May, it’s difficult to compare the trends of the two cycles and draw any definitive conclusions about the differing rig-count/oil-price responses. 

It’s worth noting that, in 2017, U.S. producers are increasing fleet sizes, along with their drilling-and-completion budgets. We sampled 16 large U.S. exploration-and-production companies that, collectively, were guiding for 21 percent capital expenditures growth, year-on-year.  

Armed with these facts, and the observations we just outlined, the U.S. land rig count’s growth in 2017 appears to be on autopilot for the rest of the year. The only thing that could stop the momentum that has already been built up is a precipitous drop in oil and natural gas prices from current levels.  

In our opinion, that scenario — an oil-price collapse — has a low probability of occurring. Our current assessment is the technical signal we highlighted at the start of our commentary appears to be a false warning light.

Think of it like the erratic tire pressure light that tends to display itself during the middle of a long family road trip — it’s probably nothing, but at the next small town you are likely to pull into a gas station and make sure there really isn’t a problem.

 

Trey Cowan is a senior analyst for Platts RigData, a forecasting unit of S&P Global Platts. 


The views expressed by contributors are their own and not the views of The Hill.