This could be a very rough year for oil drilling in the U.S. Oil prices have plunged over 50% from last year's high, and OPEC is trying to pressure U.S. shale oil production, which has become a competitive threat to its market dominance.
Most companies have put on a brave face, saying oil prices will rise eventually and that the cost of production in the U.S. isn't as high as it once was. While the cost part is true, plenty of producers cannot produce new oil wells economically for $50 per barrel, and we're already seeing the impact of low petroleum prices in U.S. oil fields.
Drilling is dropping like a rock
Oil and gas services provider Baker Hughes (NYSE:BHI), which is being acquired by Halliburton (NYSE:HAL), tracks the number of rigs in operation in the U.S. every week, and the decline in activity over the past few weeks has been startling. You can see below that the number of rigs has dropped from 1,929 in mid-November to 1,811 as of Jan. 5.
While the price of oil has been dropping for months, companies until recently had avoided pulling rigs from drilling new wells. There are a few reasons for this, such as the lag between oil prices falling and when rigs would actually be removed from service. Hedges that covered production well into 2015 could also have played a role in drilling decisions.
But it also took a long time for drillers to realize oil prices weren't going to recover anytime soon. OPEC is keeping production near 30 million barrels per day, flooding the market with oil in an effort to squeeze out marginal players. Now, the U.S. pullback from new drilling and capital expenditures begins.
Companies rush to cut spending
The drop in drilling activity will likely continue in 2015 as companies rush to lower capital expenditures.
Linn Energy (NASDAQOTH:LINEQ) announced last week that it would cut capital spending by 53% from 2014, to $730 million. Continental Resources (NYSE:CLR) once thought it would spend $5.2 billion on new drilling in 2015 but slashed its capital budget to $2.7 billion last month. The pain will be felt by service providers as well.
Halliburton, the second largest oilfield services provider, last month announced it would lay off 1,000 workers due to low oil prices. Its merger with Baker Hughes comes at a terrible time for both companies, although they might be able to cut more costs as one entity than they could as two.
2015 will be rough for U.S. oil companies
The last time we saw such a rapid drop in oil prices and oil drilling was early 2009, when the recession had its grip on the globe. That plunge was driven by low oil prices that proved to be very temporary. Today is a very different dynamic, and if OPEC is determined to squeeze marginal oil producers out of the market we could be in for a long downturn in oil prices and, therefore, new drilling.
I certainly do not expect a major recovery in oil during 2015, although a silver lining might be spending cuts from the companies mentioned above. Slower spending will help ease the supply glut in oil, and by the end of the year the industry might be on more solid footing than it was when companies were in a drilling frenzy in 2014. In the meantime, it will be a rough year for U.S. shale oil drillers and service companies.