Sustainability of crude oil price recovery depends only on sharp reduction in numbers of horizontal drilling rigs in USA

The numbers of active drilling rigs for oil production move in tandem with crude oil price. As the oil price goes up so do the number of active rigs and vice versa(Refer Chart 1). The recent crash in oil price is mainly due to the sharp increase in oil production due to increase in horizontal drilling technology mainly used in shale oil production in USA. The oil production using horizontal drilling rigs in USA increased sharply from 55% in 2011 to current level of 75% of the total active drilling rigs in USA(Refer Chart 2) due to the long period of high crude oil price averaging US$100/bbl for almost 4 years from Jan 2011 to Sep 2014. Let us understand the difference between oil price crash of 2008 and 2014.

Oil prices crashed in 2008 from high of US$134/bbl to US$43/bbl due to global economic recession and financial collapse mainly in USA and EU which led to sharp decline in demand. Now contrast this with the recent collapse in crude oil prices in 2014 at a time when USA’s economy is booming and its GDP growing at 2.6% and EU’S GDP also growing at 0.8-1.1%. The reason is sharp increase in USA oil production due to increase in numbers of horizontal drilling rigs in USA during this period. Numbers of horizontal rigs deployed in USA for oil production was 30% of the total number of rigs (USA Horizontal rig counts- 587, Total rig counts in USA-1,932) in July 2008 when crude oil price reached US$134/bbl as compared to 75% of the total number of rigs in USA (USA Horizontal rig counts-1,229, Total rig counts in USA- 1,633) last month in Jan 2015 when crude oil price went below US$50/bbl. (Refer Charts 1 & 2)

This clearly shows that recent oil price crash is not due to demand decline but mainly due to sharp and fast increase in oil production by USA using horizontal drilling rigs. As such, I believe production cut by OPEC (even if they decide to cut) is not going to help oil prices justifying Saudi Arabia’s refusal to production cut. Oil price increased by about 22% to US$61/bbl from the recent lows as 204 (17% closure) horizontal rigs shut down out of total 275 drilling rigs shut down in USA in last 3 weeks. I believe that for long term sustainability of oil industry, oil prices should remain at the current level for this year so that more horizontal rigs in USA shut down which would support the long term price of oil to be at US$80-85/bbl. As per my estimates for long term sustainability of oil industry, numbers of horizontal drilling rigs in USA should come down to 50% of the total drilling rigs in USA which would roughly means closure of about 250 more horizontal rigs in near future.

Chart 1: Crude oil price vs Rig counts in USA