Should U.S. Oil Investors Be Concerned About Declining Rig Count Numbers?

On Sept. 6, the number of operating drilling rigs in the United States fell below 900 for the first time since 2017. Month-after-month declines in rig count have weakened the stock prices of pure-play drilling companies. Although they're nearing record-low levels, let's not throw the baby out with the bathwater.

Long term investors should first choose a sector they are interested in and then focus on individual companies that cultivate shareholder value. Let's look at how four parts of the upstream oil and gas industry -- pure-play drillers, oilfield services, exploration and production, and the integrated majors -- will likely react to a dropping rig count and whether there are energy stocks within each section that are suited for a long term investment. 

Source: Getty Images

Pure-Play Drilling Companies 

Let's start with the drillers. Nabors Industries (NBR 2.58%), Helmerich & Payne (HP 0.78%), Patterson-UTI Energy (PTEN 1.07%), and Precision Drilling Corporation (PDS -1.23%), four of the most prominent oil and gas drilling companies, are all losing money. All four companies have negative earnings per share and have seen their stocks get absolutely hammered in 2019. That being said, Helmerich & Payne has remained cash flow positive. Famous for its nearly 7% dividend yield and occasional special dividend payments, Helmerich & Payne stands out as a responsible driller focused on having one of the most technologically advanced rig fleets in the business. In the meantime, H&P's earnings will suffer high depreciation levels from a previous rig upgrade.

In a recent press release, H&P guided quarterly revenue days down, representing a 6-7% decrease in the average number of active rigs. The company had exactly 200 active U.S. land rigs as of September 4th, 2019, but expects to exit the quarter at the low end of its previously guided range of 193-203 rigs.

H&P's guide down is representative of the overall decrease in West Texas drilling activity. Active rigs in the Permian Basin fell to 446, the lowest since April 2018. The largest oil field in North America continues to set record oil and gas production numbers by gradually completing existing wells despite a lack of pipeline infrastructure. As a result of this pipeline deficit, there's no incentive for operators to drill new wells despite the massive quantity of hydrocarbon reserves.

Exploration and Production (E&P) Companies

The business model of a pure-play oil and gas driller is a tricky one. These companies are responsible for drilling oil and gas wells for E&P companies such as Occidental Petroleum (OXY 0.09%) or ConocoPhillips (COP -0.41%). E&P companies focus on exploring and producing from oil wells, which makes them more concerned with oil prices than with rig count. To most of the drillers credit, many are trying to lock larger E&P and integrated companies into longer-term contracts to ensure steadier revenue and more predictable cash flow. Longer-term contracts are a huge upgrade from years past when drillers and E&Ps would rely on local spot market deals. 

Larger companies like Occidental and ConocoPhillips have diversified portfolios that largely benefit if rig count numbers improve but will also be able to weather the storm if there's more pain ahead. A declining rig count is a risky prospect that heavily affects a smaller rig company much more than a $68 billion ConocoPhillips. 

Oilfield Services Companies 

Oilfield services companies such as Halliburton (HAL 1.60%) and Schlumberger (SLB 0.26%), the two largest, make money by completing and servicing existing well in addition to leasing rigs and contracting their crews to companies like Chevron(CVX 0.75%) or ExxonMobil (XOM -0.09%), known as the operators of the well.

Halliburton has suffered nearly a 50% decline in its stock price over the past year, largely a result of a declining rig count and less frac jobs. Of even larger concern is increased production per rig, a magnificent engineering feat that benefits the industry overall but means less business for oilfield services companies. According to a recent Bloomberg story: "In June 2014, the U.S. pumped 8.4 million barrels of crude using 1,545 drilling rigs. Last month, it produced about 12.2 million barrels, 45% more, with just 788 rigs."

Supermajors

Supermajors like Chevron and ExxonMobil cannot simply choose to focus on other segments of their integrated value chain of offshore, midstream, liquefied natural gas (LNG), and downstream businesses while they wait for oil prices and infrastructure developments to improve. Both Exxon and Chevron have been accelerating their drilling programs in the Permian, each pledging to produce close to one million barrels of oil equivalent per day from the Permian alone by 2024.

The size and scale of the Exxon's and Chevron's of the world mean high level and complicated corporate initiatives with 5-10 year investment horizons that are unable to shift based on a volatile rig count. Therefore, the stability of the supermajors is really just a factor of their asset portfolios and size.

To recap, here's a table that shows the correlation to rig count by business model.

Different strokes

Each of the four upstream business models discussed responds differently to a declining rig count. For the investor bullish on a bounce in rig count, note that even the smallest pure-play drilling companies can't possibly adjust in real-time to such a volatile metric. It is, therefore, a better option to view this recent decline in rig count as a potential buying opportunity for the long-term.

Investors should choose the upstream industry most suited to their 5-10 year investment horizon, all the while paying close attention to the risks associated with each industry. Pure-play drillers and oilfield services companies, no matter how good their management is, will feel pain from a declining rig count just like E&P companies will hurt from falling oil prices. The supermajors act like diversified behemoths whose overall strategy matters more than short-term swings in rig count or oil prices. Understanding the dynamics between each upstream industry and rig count will help investors choose the industry, and company within that industry, that's right for them.