After plunging between late 2014 and mid-2016, the number of rigs drilling for oil in the U.S. rebounded sharply over the following two and a half years. Indeed, it nearly tripled over that period. Not surprisingly, this rising rig count drove strong growth in U.S. oil production.
However, a sharp drop in oil prices last fall caused oil companies to start cutting back on drilling activity. As a result, the U.S. oil rig count has fallen steadily during 2019 and is now significantly lower than it was a year ago. Nevertheless, domestic crude production has continued to rise.
The combination of a falling rig count and rising production has confounded many pundits. Let's take a look at why this is happening -- and whether it is sustainable.
The rig count falls, but production rises
The U.S. oil rig count has been on a fairly steady downward trajectory in 2019, after reaching a near-term peak in late 2018. That said, for the first several months of the year, the rig count was still up on a year-over-year basis. That's clearly no longer the case. As of Aug. 9, there were 764 oil rigs drilling in the U.S., compared to 869 a year earlier.
Despite this meaningful decline, U.S. production currently stands at about 12.3 million barrels per day (bpd), just shy of the all-time high reached earlier this year. Output first reached this level in late April, after beginning 2019 at around 11.7 million bpd. At this time last year, production still hadn't reached the 11 million bpd mark.
Thus, while domestic oil production isn't rising at the rate seen a year ago, it isn't declining, either -- notwithstanding the fact that there are 12% fewer rigs drilling for oil than at this time last year. This odd divergence is a result of the way that shale oil is extracted.
The "fracklog" is the key
Typically, oil doesn't begin to flow right after a rig drills a well in a shale formation. Instead, the process of hydraulic fracturing -- or fracking -- is used to complete the well and start the oil flowing. Yet the fracking step doesn't have to happen immediately after a well is drilled.
Between the beginning of 2014 and early 2019, the number of drilled but uncompleted (DUC) wells in the U.S. nearly doubled. (Some media outlets have dubbed this backlog of uncompleted wells the "fracklog".) Initially, that was because well completion crews simply couldn't keep up with the number of new wells being drilled. In the period after oil prices plunged in late 2014, some producers strategically waited to frack their wells and start extracting crude, hoping that prices would rise in the interim.
As a consequence of all this, right now, there's no direct connection between the rig count and oil production. New drilling won't increase production if the wells aren't being completed. Conversely, an uptick in well completions could boost production even if drilling activity falls.
Well-completion activity has been rising
The latter phenomenon has been on full display recently. With oil prices down this year, shale oil producers like Apache (NASDAQ:APA) are cutting capital expenditures. That means less drilling. But since Apache and many of its peers have large backlogs of DUC wells, they can use their limited capex budgets to complete many of those wells, boosting production -- and cash flow.
Last month, energy companies drilled 1,311 wells in seven regions tracked by the U.S. Energy Information Administration (EIA): down from 1,481 a year earlier. However, they completed 1,411 wells in those regions during July, compared to 1,277 in July 2018. Thus, a double-digit-percentage year-over-year decline in drilling was accompanied by double-digit-percentage growth in well completions.
Of course, in the long run, the two numbers have to even out: The fracklog isn't infinite. But it could take quite a while for that to happen. In the Permian Basin -- which accounts for as much oil output as the other six EIA-tracked shale regions combined -- the number of DUC wells is still rising, albeit slowly, and has tripled since the beginning of 2017.
New pipeline capacity that is starting to come on line will end the logistics constraints that have weighed on Permian production in recent years. If anything, well completion activity is likely to accelerate in the Permian Basin in the near term. That's exactly what Apache told shareholders to expect in its most recent guidance.
Shale drillers like Apache could increase Permian Basin well completions by 20% without having to ramp up drilling for a couple of years, thanks to the region's fracklog of roughly 4,000 uncompleted wells. If low oil prices continue to put a damper on drilling activity, U.S. oil output will eventually decline. However, for the next year or two at least, modest production growth driven by a focus on fracking already-drilled wells is the most likely outcome.