If you are a mineral rights owner and follow the oil and gas industry, you have likely heard references to “rigs” and “rig count”. But, what exactly is a rig and why is rig count an important metric?
Drilling Rig Definition
A drilling rig is an integrated system that drills wells, in this case oil or gas wells, into the earth. Onshore rigs are usually very tall steel structures like the image above. They are a common site in areas with oil and gas development and seemingly pop up overnight out of nowhere. Drilling rigs are portable, temporary structures that move onto a drill site where they bore through the earth in order to extract minerals. The initial ground penetration in referred to as “spudding a well” in the oil and gas industry. After a well is spud, the drilling rig leaves and a smaller “completion rig” prepares the well for production. Preparing the well for production (aka completing a well) includes fracturing the rock and installing the necessary equipment.
From wikipedia, “Oil and natural gas drilling rigs identify geologic reservoirs and create holes that allow the extraction of oil or natural gas from those reservoirs. Primarily in onshore oil and gas fields, the drilling rig moves off the well and a service rig (a smaller rig) that is purpose-built for completions moves on to the well to get the well on line. This frees up the drilling rig to drill another hole and streamlines the operation as well as allowing for specialization of certain services, i.e. completions vs. drilling.”
Rig Count
Because spudding a well is the first step (after acquiring the rights to drill and requisite permits) in the production of oil and gas, it is a leading indicator of future output. Modern oil and gas wells usually produce 40%-50% of their total lifetime production in their first year. Oil production follows a decline curve, which means the amount of oil and gas produced decreases over time. As such, in order to keep production levels flat or increasing, new wells need to be constantly drilled. Drilling fewer wells, all else equal, means overall oil and gas output decreases. Conversely, increasing the number of wells increases production.
In the United States, the combination of horizontal drilling and hydraulic fracturing of shale rock led to a doubling of U.S. crude oil production between 2008 and 2020. The oil crash of 2020 cut into production growth and the resulting lack of rig activity will further reduce production.
Rig Count Trends
From 2011 to the end of 2014, the U.S. rig count hovered around 2,000. The 2014 oil price bust sent the rig count in a free-fall until it bottomed out in the middle of 2016 at around 400 rigs. From 2016 to 2018, activity picked up again and by 2018 there was around 1,000 active rigs. A steady decline followed in 2019 and into early 2020. Oil prices stayed stagnant around $50 per barrel, which is too low a price for many operators to justify drilling.
COVID-19 and the Saudi-Russia price war sent oil prices tumbling in March and April 2020. This brought U.S. drilling activity to a screeching halt. After 9 consecutive weekly declines, the number of active rigs fell from a little over 800 in March 2020 to less than 275 by July, a decrease of 70% in just 3 months. This is the lowest rig count on record. In fact, it is believed to be the lowest number of active rigs ever in the United States, dating all the way back to the late 1800’s when oil was first commercially produced.
To illustrate the severity of this decline in activity, the DJ-Basin, which covers all of Colorado, only had 3 active rigs in July 2020. This is a 90% decrease from the year prior and is down from over 60 rigs from the 2014 peak. The state of Wyoming, whose Powder River Basin has been the ‘next big play’ for several years now, had ZERO rigs drilling in July 2020.
Rig Count and Mineral Rights
Mineral rights only have value to the extent that the underlying oil and gas can, and will, be extracted profitably. Decreasing drilling activity diminishes the likelihood that minerals, and thus their value is also diminished. The resulting frenzy of drilling activity from 2008 through 2017 in response to the “shale revolution” may never be seen again. Investors who fueled this growth got burned by the subsequent oil price busts of 2014 and 2020, and likely have learned their lesson. In the future, oil and gas companies will have to employ a more measured approach and focus more on getting more out of each well rather than drilling more and more wells. As a result of the recent price crash, tens of thousands of drilling permits continue to expire with no drilling. Operators let leases expire, rather than drill to hold them.
Summary
As a mineral owner, it is important to be aware of rig count trends. Enversus DrillingInfo and Baker Hughes provide weekly updates. Stay current on what is actually happening in the market. Don’t do yourself the disservice of anchoring to out-of-date information. Drilling rig counts are a clear indicator of how bullish or bearish operators are on the market and may indicate how likely the future drilling of your minerals is or is not.
