After nosediving for several months and bottoming out in June, U.S. oil rig count is finally beginning to rebound. The figure has been rising for several consecutive weeks, and now stands at 672 (up from a low of 628). Still, the count is less than half of what it was at this time last year.

But what is rig count, and why does it matter?

Oil rig count is a tally of active drilling rigs. It is an important indicator of drilling activity, and a way for investors to assess near-term need for oil drilling contractors and suppliers.

Rig count cycles over time, roughly corresponding with oil prices. When prices drop, less efficient wells are no longer worth the investment. As the returns tank, oil firms decide to idle under-producing wells. However, it may be some time after these decisions are made before the rigs actually become inactive, since the companies are often locked into long-term contracts. Morgan Stanley notes that U.S. rig count historically bottoms out approximately 25 weeks after exploration and production firms make such decisions.

Production is Key

Due to the law of supply and demand, analysts predict that idling rigs will slow production, eventually leading to a recovery in oil prices. However, a rig count decrease doesn't necessarily result in lower overall production right away. As wells age, it becomes more difficult to extract the remaining oil. These less efficient wells are idled first, while newer wells may produce more than enough to offset the losses from those that go offline.

Production also depends on the type of well idled; horizontal wells are more productive than vertical ones. The plays in which new and idled wells are located also make a difference. Rig count changes in the most productive oilfields in the Bakken, Eagle Ford, and Permian plays are the most significant.

Making Predictions with Rig Count

Rig count change for a given week is not all that useful on its own. Investors should evaluate longer-term trends over the course of several weeks to understand the industry's condition. When the count begins to drop consistently, expect the need for oil services firms (and their profits) to drop with it.

The numbers are most revealing when paired with the monthly Drilling Productivity Report. Investors need both metrics because oil production, or supply, is what determines prices. The industry carefully adjusts drilling activity (reflected by rig count) to influence supply and smooth out price fluctuations. Stakeholders need to examine the two interconnected indicators to get the full picture. A solid understanding of how they interact can help you extrapolate trends and assess the potential for oil market downturns and recoveries.

One analyst recently used the two metrics to presage that U.S. oil production would continue to rise in 2015 despite a falling rig count, suggesting that prices will remain low. The prediction, posted at OilPro by Gary Flaharty of SCLinx Inc., is based on observations of a one to two year lag before increasing rig count was reflected as increased production during the oil boom of 2005-2014. “[N]o more than 500 oil-directed drilling rigs [may be needed] to maintain 'flat' production,” he adds. Such predictions signal how profitable oil-related firms are likely to be, and how prices are likely to respond. And since many industrial, commercial, and consumer goods are made or transported with petroleum, the cost of crude is a harbinger of the economy as a whole.

Does Peak Oil Exist?

Some environmentalists also use this approach to watch for the arrival of peak oil. Plateauing production from an increasing number of rigs will be the canary in the coal mine for the industry, clean energy advocates at Peak Oil Barrel and the Association for the Study of Peak Oil&Gas believe. Hydraulic fracturing, horizontal drilling, and other advancements in enhanced oil recovery, however, have all but killed off the concept of peak oil - at least for the foreseeable future. A bevy of industry experts have cited increased production from fewer wells as confirmation of the end (or postponement) of peak oil.

Still, the idea of peak oil may be evolving. “[E]ven if oil continues to flow, the planet's atmosphere is getting closer to something that might be called its 'peak carbon' carrying capacity,” Eddie Scher of the Sierra Club's "Beyond Oil" campaign told E&E Publishing. Concerns about carbon emissions and clean energy innovations may eventually usher in the decline of oil, rather than dwindling supplies.

Even the Saudis may agree with this assessment. While OPEC has historically adjusted its production to control oil prices (mainly through Saudi Arabia), it refused to do so last November, despite a more than $30 drop in cost per barrel within six months.  

The question is why. While many analysts believe the Saudis are leveraging low prices to shut down wells in other countries and regain market share, energy finance advisor Elias Hinckley theorizes that the oil barons see which way the energy winds are blowing. “Thirty years from now there will be a huge amount of oil – and no buyers," former Saudi oil minister Sheikh Yamani said in 2000. "Oil will be left in the ground. The Stone Age came to an end, not because we had a lack of stones, and the oil age will come to an end not because we have a lack of oil.” The country may be selling off as much oil as it can before that time comes.

The United Nations Environment Programme reported a 14 percent drop in renewable energy investment worldwide in 2013, due in part to cost reductions in solar photovoltaic systems and policy uncertainty in several countries. Still, renewable energy accounted for 43.6 percent of newly installed generating capacity in 2013. Overall, its market share of world electricity generation rose to 8.5 percent, up from 7.8 percent in 2012. Innovations like the Tesla Powerwall, an affordable home energy storage device unveiled in early May 2015, may speed the transition to renewable energy.

If and when the fuel mix changes enough to significantly reduce demand for crude, the price of oil can be expected to drop for good, and oil rig count along with it. Until then, the two industry barometers will continue to follow – and foretell – oil prices.

 

Companies to Watch

Shareholders have been keeping an eagle on how rig count changes are affecting petroleum stocks associated with oil companies like ConocoPhillips (NYSE: COP), Chevron Corporation (NYSE: CVX), and Exxon Mobil Corporation (NYSE: XOM).

 

Shares in oilfield services firms are also heavily impacted by rig count. Investors interested in the state of the industry may want to monitor the key contractors listed below.

Halliburton Company (NYSE: HAL)? One of the world's largest oilfield products and services companies.

Schlumberger Limited (NYSE: SLB) The world's largest oilfield services company. Schlumberger provides a wide range of services throughout the drilling process, from exploration to production.

Baker Hughes Incorporated (NYSE: BHI)?An oil services firm and source of the rotary rig counts. Baker Hughes has collected, calculated, and distributed the Baker Hughes Rig Counts since 1944.

Industries Ltd. (NYSE: NBR)?An onshore and offsfhore oil drilling and equipment company.

Helmerich & Payne (NYSE: HP)?A Tulsa, Oklahoma-based drilling contractor.

Continental Resources, Inc. (NYSE: CLR)?The largest leaseholder in the Bakken shale formation of North Dakota.

Weatherford International plc (NYSE: WFT)?An oil and gas service company with a leading portfolio of well stimulation and production methods.

 

Kate Dougherty is a freelance writer and geographer specializing in stories about where science, technology, and the environment meet. Her work has been published by Earth Island Journal Online, Next City, EnvironmentalScience.org, and the American Society for Mechanical Engineers. Prior to her freelance career, she was contracted to the U.S. Environmental Protection Agency libraries for six years, and also served as Assistant Professor/Geosciences and Maps Librarian at the University of Arkansas.