Oil Rigs’ Decline Continues Unabated
April 2020 brought one of the most extraordinary events in financial history – the price of oil fell to negative $37 before bouncing back to zero. With economies in shut down mode, holders of May delivery futures contracts were willing to pay up to $40 for avoiding the physical delivery of crude oil.
The drop in the oil price continues to create victims, especially in the US shale industry. The recent Russia-Saudi Arabia disagreement on cutting production levels was viewed as a way for Russia to hurt the US shale industry (the US became a net oil exporter in 2019 after decades losing that status). The Baker Hughes rig count in the United States shows that the number of rigs continues to fall – down another 35 rigs in the week ending May 15, adding to over 600 lost rigs in a year.
Challenges for the US Shale Oil Industry
The shale industry is strongly affected, given the reduction in the number of rigs. Unsurprisingly, many producers sell their output below production costs as demand for oil products collapses. For instance, world air traffic is 62% below pre-crisis levels, albeit it rebounded a bit as economies begin to lift up restrictions.
The number of rigs in the Permian Basin is down a full 47% lower during the same period of last year, reflecting the challenges that shale producers face. Moreover, the rig’s decline is likely to extend.
A survey of investors and industry participants by investment bank Cowen resulted in a more bearish sentiment on the North American shale industry than it is currently reflected in the market. According to Platts Analytics, US producers must shut over 3 million barrels per day in output for the next several months to offset declines in demand caused by the coronavirus pandemic.
Baker Hughes rig counts are important for understanding the oil industry – drilling and suppliers. The number of active rigs acts as a leading indicator of demand for products used in producing and processing hydrocarbons, and a leading indicator of economic growth.
Economic growth spurs higher oil consumption, and investors look for early signs that demand in oil products picks up – an increase in the number of rigs suggests the economy picks up, and the business cycle may turn.
Therefore, in the context of the current economic recession, a pickup in the number of rigs offers an optimistic perspective for the world economic recovery to begin.