The U.S. rig count increased by 19 this week as oil prices dropped below $48 per barrel–the latest sign that the E&P industry is out of touch with reality.



Getty Images from The New York Times (July 26, 2015)

The last time the rig count increased this much was the week ending August 8, 2014 when WTI was $98 and Brent was $103 per barrel.

What are they thinking?

In fairness, the contracts to add more rigs were probably signed in May and June when WTI prices were around $60 per barrel (Figure 1) and some felt that a bottom had been found, left behind in January through March, and that prices would continue to increase.



Figure 1. Daily WTI crude oil prices, January 2-July 24, 2015. Source: EIA and NYMEX futures prices (July 21-24).

(click image to enlarge)

Even then, however, the fundamentals of supply, demand and inventories pointed toward lower prices–and still, companies decided to add rigs.

In mid-May, I wrote in a post called “Oil Prices Will Fall: A Lesson in Gravity”,

“The data so far says that the problem that moved prices to almost $40 per barrel in January has only gotten worse. That means that recent gains may vanish and old lows might be replaced by lower lows.”

In mid-June, I wrote in a post called “For Oil Price, Bad Is The New Good”,

“Right now, oil prices are profoundly out of balance with fundamentals. Look for a correction.”

Oil prices began falling in early July and fell another 6% last week. Some of that was because of the Iran nuclear deal, the Greek debt crisis and the drop in Chinese stock markets. But everyone knew that the first two were coming, and there were plenty of warnings about the the Chinese stock exchanges long before July.

The likelihood of lower oil prices should not have been a surprise to anyone.

Of the 19 rigs added this week, 12 were for horizontal wells (Figure 2) and 7 of those were in the Bakken, Eagle Ford and Permian plays that account for most of the tight oil production in the U.S.



Figure 2. Rig count change table for horizontal wells. Source: Baker-Hughes and Labyrinth Consulting Services, Inc.

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Horizontal shale gas plays added 8 rigs. That is as out-of-touch as the tight oil rig additions since gas prices averaged only $2.75 in the second quarter of 2015 (Figure 3) and are almost half of what they were in the first quarter of 2014.



Figure 3. Henry Hub natural gas daily prices and quarterly average prices.

Source: EIA and Labyrinth Consulting Services, Inc.

(click image to enlarge)

The U.S. E&P industry is really good at spending other people’s money to increase production. It doesn’t matter if there is a market for the oil and gas. As long as the capital keeps flowing, they will do what they do best.

Don’t be distracted by the noisy chatter about savings through efficiency or re-fracking. Just look at the income statements and balance sheets from first quarter and it’s pretty clear that most companies are hemorrhaging cash at these prices. Second quarter is likely to be worse and it gets uglier when credit is re-determined in Q3, hedges expire, and reserves are written down after Q4.

This is an industry in crisis despite the talk about showing OPEC a thing or two about American ingenuity. Increasing drilling when you’re losing money and prices are falling doesn’t sound very ingenious to anyone.

Watch for the markets to agree as oil prices fall lower in coming weeks.