How To Explain The Falling U.S. Rig Count Amid Rising Oil Prices

In the past, oil and gas drillers in the United States would invariably activate every dormant drilling rig they could locate and rent whenever commodity prices rose substantially. They would not only activate the rigs, but they would ramp up drilling budgets until they inevitably drilled so many wells that the resulting supply response overwhelmed global demand and crashed prices to lower levels than when the boom began.

One of my good friends had a saying for this highly predictable phenomenon: “You can always rely on the industry to drill itself out of prosperity,” he would say. He retired a few years ago, but if he were still active, he would have to modify his dictum now to conform it to today’s new reality. Because it seems we can’t rely on the industry to do this to itself these days.

Prices Rise, Rig Counts Drop

The U.S. industry’s new reality sees the domestic active rig counts dropping even in the face of some of the strongest commodity prices in history. For the week just past, both Baker Hughes and Enverus reported double-digit drops in their respective counts. The Baker Hughes count published Friday fell by 11, and now stands 149 rigs lower than it stood at the first of the year.

The Enverus weekly count, released Thursday, fell by a full dozen from the previous week, and is now down for the year by over 20%. Both counts are roughly 40% lower than at the end of 2019, despite the fact that crude prices are more than $30/bbl higher today than they were then.

So, what factors are causing this lack of any drilling response at all from the U.S. domestic industry in a time of elevated prices and high demand? Some want to blame it all on the Biden administration’s efforts to restrict leasing and drilling on federal lands, but that’s wrong-headed. Those policy choices have had an impact that will become more prominent over time, but there are other factors at play here.

First and perhaps foremost among those factors is the overall prevailing mindset among management teams at corporate upstream companies. That hive mindset favored huge drilling budgets and drilling new wells as rapidly as possible in the shale oil boom years from 2010 through 2018. This was the accepted way companies grew during that time, even though doing so involved taking on often overwhelming levels of debt and causing frequent bankruptcies during those years.

Viewed through the perspective of industry history, this has always been the pattern whenever discoveries of major new oil or natural gas resources take place, and no resources have ever been more prolific than those contained in North American shale reservoirs. While many bemoaned the process, this was in fact the normal course of development.

The Hive Mind Shifts

This hive mindset began to shift around mid-2018, as investors grew weary of issuing more and more new debt to upstream companies who too often fell into bankruptcy amid all-too-frequent bust cycles. This, combined with rising pressure on the ESG front, led to a kind of forced focus on increasing investor returns by these upstream corporations, who started limiting and even cutting back drilling budgets in favor of focusing on developing efficiencies, streamlining processes, cutting head counts and growing through acquisition and mergers rather than the drill bit.

Over time, that forced focus has evolved into a preferred way of doing business. Management teams, often led by engineers with a heavy bias towards drilling more wells, accepted their new lot in life and found ways to not just endure, but thrive in this new mode of operations. As I wrote here as early as mid-2021, these corporate producers had developed a new, different comfort zone and would only be changing it again if and when market factors demanded doing so.

The Bottom Line

Even at this time of strong commodity prices and rising consumer demand, market factors simply aren’t dictating any major change in this new comfort zone management style. So long as the corporate upstream producers are able to maintain and increase per-well recoveries and grow their inventories of new drilling prospects through mergers and acquisitions, this paradigm seems unlikely to change.

Given that reality, there is no real reason to expect any major shift in direction for domestic rig counts through the end of 2023.