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Increase in US rig count will not cap oil prices

By David Yager - posted Friday, 24 June 2016


The impact of rising oil prices on North American light tight oil (LTO) production is said to be a “Catch 22”, the title of Joseph Heller’s popular 1961 novel set in WWII. The premise was you could get out of the army if you were crazy but you weren’t crazy to try to get out of the army. So this avenue to escape the war didn’t work for the book’s main character John Yossarian.

Too many analysts continue to believe drilling and service has the same problem with rising oil prices. With WTI back above $50 a barrel – at least briefly last week – North American LTO developers are putting rigs, service equipment and personnel back to work. The so-called “fraclog” or “DUC” inventory (wells drilled but uncompleted) is being reduced. While this is good it is also thought by some to be temporary.

Those who study crude prices have correctly observed it was the 4 million barrels per day (b/d) increase in US LTO production that contributed greatly to the 2014 oil price collapse. So if the price of oil is now high enough to make LTO economic again some believe the reward will either be a cap on further price increases or the foundation of the next collapse. The Catch 22 is if oil prices rise high enough to put drilling and service back to work then it won’t last long.

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Maybe.

To this writer the most meaningless indicator of the future of world oil prices has been the weekly US oil rig count published by Baker Hughes and opined upon regularly by oil analysts and writers since late 2014. That’s when it became an important world oil price driver for the first time. The argument emerged that having contributed to the collapse of world oil prices, US LTO was the new global “swing producer”, replacing OPEC leader Saudi Arabia in that role. If and when prices rose the US rig count would rise and ultimately cause prices to fall again. If prices went too low the LTO operators couldn’t afford to drill, which would shrink supply and cause prices to rise.

This is materially different than prolific oil producer Saudi Arabia, which established its swing producer credentials over several decades merely by opening and closing valves. The geological and commercial differences between the two couldn’t be more glaring. In the Middle East a single state oil company is exploiting arguably the most prolific reservoirs in the world. A state-controlled entity can do whatever it wants including shutting in production to manipulate prices without fear of prosecution.

In the US hundreds of operators run thousands of rigs to exploit arguably some of the most expensive and geologically complex reservoirs in the world. If they somehow collude to restrict supply to affect prices they will be prosecuted and perhaps sent to jail. Whoever came up with this idea really should do more homework.

Nevertheless, the comparison got legs and away it went. With world oil prices being a huge business story analysts started to focus their attention on the weekly US oil rig count as a precursor of when US LTO would fall. Every Friday the Baker Hughes rig count would wiggle. If it went down WTI might tick up. If it went up WTI might tick down. WTI is the most heavily traded and speculative commodity in the world some days trading 1,000 times as many “dry” barrels (futures contracts) as “wet” barrels (actual oil production priced off WTI).

Besides massive futures trading, the other factors affecting WTI include the value of the US dollar (it rises and WTI falls), OPEC production, world oil demand, North American and US storage, Iranian crude embargoes, and periodic and unplanned supply disruptions from everywhere from Libya to Nigeria to Fort McMurray.

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Regardless, the US oil rig count regularly makes the news and affects the price of WTI. The following chart shows the figures for the past 19 months since it peaked in October of 2014 at 1,609 and hit the lowest level in years at only 316 in late May, merely 20 percent of the high water number.

IMG URL: http://cdn.oilprice.com/images/tinymce/2016/Yag1sss.png

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This article was first published on OilPrice.com.



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About the Author

David Yager writes for OilPrice.com.

Creative Commons LicenseThis work is licensed under a Creative Commons License.

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