A Dramatic increase in rig counts spells trouble for crude’s rally

The price of WTI crude has risen dramatically in recent months as a result of weather-related production challenges, increased global demand and a relatively well-coordinated OPEC policy aimed at limiting production. As a result, WTI crude oil closed out last week at $64.30/bbl. On January 2 of this year, WTI closed above resistance at $60/bbl and it has not looked back. In late November, I called for WTI crude to run into resistance at $60/bbl, and it did find headwind there briefly-but only briefly. Crude’s breakout above $60/bbl has set it up for a potentially meaningful move higher. Some are calling for $80/bbl. I suspect that WTI crude does not rally to $80/bbl in the near-term for several reasons.

Crude oil has been on a breakout trade since January 2 and as a result has driven shares in the energy sector higher even though no earnings results for Q4 have yet been released.

With the sharp rise in prices experienced by crude oil and with its recent breakout to highs not seen in three years, US production has responded by ramping up quickly. Last week’s Baker-Hughes rig count data underscores that point. As the chart below illustrates, the total North American rig count rose by 117 in the week ending last Friday, January 12 ending at 1215. Importantly that rise in rig counts came across all three verticals: the U.S., the Gulf of Mexico, and Canada. For the previous week ending January 5, the rig count rose from 33 to 1098. That was the week WTI crude closed above $60/bbl. In the Week ending December 29 of 2017, the rig count rose 24 to 1065. It is clear to see that there is a direct correlation between crude pricing and rig count, and as a byproduct, ultimately production. The higher the price of crude, the more the rig count rises to meet demand. That increase in production will hamper meaningful moves higher in crude in coming quarters.




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