It’s getting quite depressing in the energy sector and for various oil stocks. So depressing, in fact, that oil service company Baker Hughes Incorporated (NYSE:BHI) has decided to stop reporting quarterly well count numbers for the U.S. and the rest of the world.
That’s because, after weeks of declines, we may have finally hit the point that the decrease in rigs working will finally start chipping away at supplies. That’s hugely bullish news for crude oil prices and ultimately, oil stocks and portfolios.
The time to buy equities in the energy sector could be at hand.
Oil Rigs Decline by More Than 50%
The culprit for oil’s continued downward slide in prices can be summed up in one word: oversupply. As we’ve fracked North America’s various shale formations, we have continued to build up huge supplies of crude oil here in the U.S.
Those supplies have reached record levels not seen in decades. In fact, the EIA estimates that we have enough crude oil to last a full 29 days’ worth of refinery demand. That’s the most oil sitting in storage tanks, terminals and tank cars since 1985.
And since demand for oil — thanks to changes in driving habits, efficiency measures and relatively muted economic growth — has dropped off hard, prices for crude oil have fallen from a peak of around $107 last June to around $44 per barrel today.
So it stands to reason that, if you’re a producer of oil, you would try to cut your production, help dwindle the supplies and potentially raise the price of your product. That’s basic and rational economics. And it’s exactly what the energy sector has done.
The latest Baker Hughes rig count report has shown that the number of drilling rigs has declined for the seventeenth week in a row. The number of drilling rigs prospecting for oil now sits at just a measly 802. That’s the lowest level since Mar 2011 and is more than 50% below the record 1,609 oil rigs reached in October of last year. Unfortunately, those major declines in drilling rig activity haven’t yet translated into a drop in actual output.
The key word is yet. That 50% drop may finally be the turning point were the lack of drilling starts to hit production numbers.
During BHI’s latest earnings report and conference call, the oil service company noted that, based on its historical rig count data, oil rigs will decline between 40% and 60% during a bust cycle. And we’ve already seen some evidence of the decline bottoming out. The recent few weekly oil rig reports have seen progressively fewer declines as oil stocks have removed many of their least-efficient rigs.
With those older, less-efficient rigs now out of the picture, production should begin to slow. Fracking is amazingly efficient at getting oil out of the ground fast. The problem is you need to keep fracking and fracking in order to keep that up. Wells drilled in 2012, 2013 and early 2014 should begin to show their age. And while re-fracking and enhanced oil recovery techniques can breathe new life into these slowing wells, at $40 per barrel that’s just not economical.
With that said, analysts at Bank of America peg that 1,000 operating oil rigs is what is needed to keep production steady over the course of the year. At only 800 rigs, production should decline by the second half of the year.
Those moves will ultimately boost oil prices as well.
Time To Buy Oil Stocks
With data on production lagging rig counts by several months, investor may have an opportunity to front-run a potential rebound in oil stocks. We’ve basically hit “rock-bottom” and could be at the inflection point with regards to lower production, higher crude oil prices and increased share prices for the energy sector.
There are basically three plays here.
Investors can take a broad approach and make a big bet on an ETF like the Vanguard Energy ETF (NYSEARCA:VDE). VDE follows a wide swath of energy firms covering the entire value chain, including up- mid- and downstream stocks. With its low expenses (just 0.12%), VDE makes a great core energy holding and perhaps a bargain now that oil prices could finally turning around.
Or they can get a bit more concentrated with something like the SPDR S&P Oil & Gas Exploration & Production. (ETF) (NYSEARCA:XOP). XOP follows strictly those firms that engage in the production of oil and other fossil fuels. The fund is equally weighted, so smaller shale producers and drillers have the same pull on the fund’s returns as the big boys. As such, the XOP makes a great direct play the rebound in oil prices. After all, the smaller fries have much more at stake — in some cases their very survival — with oil prices being this low. Expenses for XOP run 0.35%.
Want an even more concentrated option? How about the owners/operators of the most advanced land drilling rigs? Stocks like Patterson-UTI Energy, Inc. (NASDAQ:PTEN) and Helmerich & Payne, Inc. (NYSE:HP) have seen their share prices dwindle along with their day rates. A flattening out of the rig count numbers would provide the biggest benefit to them. Owning some of the most advanced walking oil rigs, they are basically the last ones standing — the ones getting all the business.
The Bottom Line
We may have finally hit the inflection point for how many rigs need to be taken out of commission to finally cut supplies. Ultimately, investors are being given the best buy signal for oil stocks for the next leg up.
Whether you’re looking at ETFs like the VDE or XOP or land-drilling single stocks, the time to buy is at hand.
As of this writing, Aaron Levitt was long VDE.