Rig count matters. Saying that it doesn’t is like a realtor saying that location doesn’t matter.

Rigs Don’t Produce Oil

The holiest mystery of shale plays is that so much production is possible with ever-fewer rigs.

But if we look at the number of producing wells, the mystery evaporates. That’s because rigs don’t produce oil and gas. Wells do.

Horizontal wells in a few tight oil plays tell most of the story for U.S. production. Figure 1 shows the rig count and number of producing wells for the Bakken, Eagle Ford, Permian, Niobrara, Mississippi Lime and Granite Wash plays.

Although rig counts decreased dramatically beginning in late 2014, the number of producing wells continued to increase until very recently. This may be a technical triumph for the drilling industry but it is no cause for oil producers to celebrate.

Average well costs are approximately $6 million so, despite falling rig count, the tab for new producing wells was about $3.9 billion per month in 2015. Add to that the cost of wells waiting on completion and other non-capital costs of doing business.

Many analysts and producers want us to believe that producing tight oil has become almost free thanks to awesome advances in efficiency and technology.

A rough rule of thumb is to multiply the monthly change in tight oil horizontal rig count by $6 million to approximate how much money is spent for new producing wells. There were about 2,400 more producing wells in 2015 than a year earlier in the Eagle Ford ($6 million per well) and 2,600 more in the Permian basin plays ($6.5 million per well). That works out to about $14 billion and $17 billion, respectively. For the Bakken where wells are about $8 million apiece, the cost for 2015 was $13 billion.

$45 billion for new producing wells in the 3 main tight oil plays in 2015—almost free.

Rig Count Matters

Rig counts are sensitive to price changes and generally excellent indicators of future oil production.The 4-week aggregate of weekly rig count changes accurately and quickly reflects changes in WTI price (Figure 2).

Oil prices began to fall in October 2014 and reached an initial bottom in January 2015. Monthly rig count change went negative in December 2014 and reached a maximum negative change in February 2015. When prices began to increase in April 2015, rig count change responded almost immediately.

Similarly, oil production followed changes in horizontal tight oil rig count quite closely and this includes total U.S. crude oil production, not just tight oil production (Figure 3) .

Production began to decline after April 2015 only 2 months after the maximum negative rig count change occurred in February.

Separating The Signal From The Noise

Oil companies tell us stories about new fracking technology, drilling productivity gains, and drilled uncompleted wells. These are mostly noise designed to distract us from the fundamental signal that the companies are losing a lot of money.

In order to navigate the uncertainties of investment, it is essential to separate the signal from the noise.

Companies and the minions of analysts and journalists would have us believe that rig count no longer matters. Pad drilling has relegated it to an anachronistic past that no longer applies in the brave new world of shale production where energy is impossibly cheap, abundant and profitable. This is a magical world where as the number of rigs approaches zero, oil production approaches infinity.

In this brief post, I have shown how that looks against the stark backdrop of facts. Rig count matters but it is only one factor that serious analysts use to try to decipher the signal amidst the deafening noise of oil-industry commentary.

The real signal is that all tight oil plays are losing money at current prices and will continue to lose money until oil prices reach and sustain approximately $65-75 per barrel. That scenario makes the doubtful assumptions that vast amounts of new capital will be available to E&P companies, and that the oil-field service industry will recover quickly. It is equally probable that oil prices languish well below the cost of production too long and that the E&P and service industries may never be the same again.

Investors should contemplate those alternative realities carefully. That will be possible only if the signal can be separated from the noise.