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Will a Higher Rig Count Reverse the Current Crude Rally?

Zacks Equity Research

Energy markets witnessed two and half years of weak oil prices on the back of a supply glut. After repeated cries all this time for big oil producers to stop fighting for output share, OPEC and non-OPEC crude producers finally decided to limit output in a landmark accord.   

Hailed as the most important move in years by the oil producers to restore prices, it was also the first time in 15 years that a deal was struck between OPEC and non-OPEC producers to jointly curb crude production.

Against such a backdrop, many analysts are expecting crude to improve further from its 18-month high level of $55.24 a barrel. However, things are not that simple and we need to focus on the big picture of increasing oil rigs in the U.S. plays –– now for more than 20 weeks.

It seems that domestic shale companies have been gathering rigs in the plays for more production, which could again create a downward pressure on oil prices.

Now, the billion dollar question is whether increased U.S. drilling will pause the improvement in oil prices.

Oil Producers Join Hand to Cut Output

Acknowledging that the market is flooded with plentiful supply of crude, non-OPEC players have teamed up with OPEC to curb oil production.

On Nov 30, 2016, OPEC reached a historic accord to lower its production by 1.2 million barrels per day (MMB/D) to 32.5 MMB/D – effective Jan 1, 2017 – from 33.6 MMB/D. Notably, the production cut is much more than what was projected by most analysts. It is to be noted that Saudi Arabia – the most influential OPEC member – agreed to shoulder most of the output cut.

Shortly after that, non-OPEC players jumped on the bandwagon. Given this decision, the market will see reduction of an additional 558,000 barrels per day of crude.

Of the declared amount of non-OPEC cut, Russia alone will reduce output by 300,000 barrels per day. The country has pledged the bulk amount as it produces more oil than the other countries. We note that 10 other players including Oman, Azerbaijan and Sudan have also decided to lower output. Most importantly, Saudi Arabia surprised analysts with the indication of further production cut after the accord with non-OPEC producers.  

Oil Rigs Increasing Steadily After the Deal

In its weekly releases, Houston, TX-based oilfield services company Baker Hughes Inc. BHI reported that in the last 26 weeks, oil rigs increased 24 times. Most importantly, the latest oil rig count – that stands at 525 – is the highest since Dec 31, 2015.

We believe that the momentum will continue in the coming days too as the present state of affairs is being considered by many as an opportune moment for U.S. shale players to outpace OPEC in the race for production share. With the cartel’s output cut, U.S. energy companies are well poised to take advantage of higher oil prices in the coming days by churning out more oil.

Some U.S. exploration and production firms that stand to gain from the aforesaid developments are Sundance Energy Australia Ltd. SNDE, Abraxas Petroleum Corp. AXAS, Bill Barrett Corp. BBG, Comstock Resources, Inc. CRK and Concho Resources Inc. CXO. Sundance sports a Zacks Rank #1 (Strong Buy), while Abraxas, Bill Barrett, Comstock and Concho carry a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Trump’s Energy Policy Could Support Drilling Further

The Obama administration’s decision to restrict oil and gas drilling in offshore plays of Atlantic and Alaska was strongly supported by environmentalists.

However, Trump intends to boost energy self-sufficiency of the U.S. and hence plans to open up drilling activities in these offshore resources. Trump also promised to integrate more federal acres of land for oil and gas drilling operations.

Conclusion

It is very tough to predict weather the continued rise in oil rigs could reverse the current momentum in oil prices. If U.S. oil production surpasses the production cut of both OPEC and non-OPEC players then crude could go down.

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