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Rising US rig counts slow as oil prices remain below $50/b

There are many contributing factors that are causing US oil prices to remain suppressed. Part of the reason is that petroleum inventories are not declining as quickly as some market participants had expected. Also, there are concerns that persistent production growth in the US will delay the market’s ability to balance. Additionally, production has rebounded in Libya and Nigeria, which has offset some of the efficacy of the OPEC-led production cut.

As a result, WTI oil prices have been hovering around $47/b the past three months, reaching as low as $42.53/b on June 21, and we are starting to see some hesitation on the part of the US producer. Through the first five months of 2017 the US rig count grew by 45% (or 300 rigs), which equates to adding 60 rigs per month. Over the last month, however, the pace of growth has slowed dramatically — increasing only 4% (or 36 rigs), bringing the US total to 1,050 rigs for early July.

If prices remain below $45/b, producers will most likely decrease drilling efforts because of internal rates of return below 20% (light blue bars below) for all plays except the Permian, according to the Platts Well Economic Analyzer. If a typical well within a play averages over a 20% return, it usually leads to a steady increase in new drilling activity within that play. To that point, if prices climb back over $50/b we could expect rig activity to grow since returns would rise above that 20% threshold (dark blue bars below) in the top oil-rich plays: the Permian, STACK, Denver-Julesburg, Eagle Ford and the Bakken.

IRRs for selected plays

These are very interesting times in the marketplace. To illustrate the tight trading range, I created the chart below to outline some of WTI’s recent resistance levels, or high price points (green prices), and the support levels, or low prices (red prices). Resistance and support levels provide a trading range and when those levels are tested, the price will either bounce off or break through those barriers — creating a new trading range. As we can see over the last four months, any time WTI has attempted break through the $45-$50/b range it was quickly corrected.

WTI recent resistance and support levels

Looking forward, if prices remain between $45-$50/b, we will most likely see rig counts hold at current levels because there isn’t the financial upside to continuing to add rigs at the previous pace of 60/month. If prices rise above $50/b and producers respond by ramping up oil production it would most likely cause the rally to be short-lived. Currently, the S&P Global Platts price forecast for WTI over the second half of 2017 is $44.87/b and the 2018 average only grows to $49.40/b. This means rigs may be stuck in a holding pattern for the next year and half (barring any outside factors).