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Raymond James: U.S. Oil Rig Count May Decline in 2013

The U.S. government and private energy analysts appear to have come to a foregone conclusion that the domestic natural gas drilling rig count will take a dive in 2013, but if any are "blindly assuming" that the U.S. oil rig count will "continue to move up and to the right," they may be wrong, said the team at Raymond James & Associates Inc.

Domestic oil output is "climbing at an extraordinary pace," analyst J. Marshall Adkins and his team wrote in a note to clients. The most recent Energy Information Administration data for January "suggests that year/year [y/y] U.S. oil supply is up more than 500,000 b/d over last January...well ahead" of the firm's recently published 2012 U.S. supply model.

"Combining this growing U.S. supply with declining oil demand (in Organisation for Economic Co-operation and Development countries) and the emerging oil fundamentals for 2013 leaves us staring down the barrel of lower oil prices," Adkins wrote. "While most are blindly assuming that the U.S. rig count will continue to move up and to the right, our oil model now points to a necessary reduction in U.S. drilling activity."

The Raymond James team now assumes that the 2013 natural gas rig count "should have a full-year average of 500 rigs, which is down 135 rigs from our previous forecast, or 130 rigs y/y (90 dry gas rigs and 40 wet gas rigs)." They also assume that the 2013 oil rig count should have a full-year average of 1,455 rigs, down 70 rigs from their previous forecast, or up 75 oil rigs y/y."

The net result "is a full-year average of 1,955 rigs for 2013, or a decrease of roughly 60 rigs y/y (or 3%). More significantly, this compares to our previous annual average forecast of 2,160 rigs, which was up net 130 rigs (plus 230 oil, minus 100 gas). We believe this 200-rig swing from our previous average annual forecast will have a meaningful negative impact on oil service activity, pricing and subsequently earnings for 2013.

"Put another way, our year-end 2013 U.S. rig forecast is now down over 400 rigs (or about 18%) from our prior forecast, which was largely in line with consensus," Adkins said.

The "oil problem" won't show up until later this year, said the Raymond James team, and it's "impossible to forecast the exact rig decline needed to rebalance the oil system" going into 2013 because too much may change a year from now. Rather than focusing on a specific number, "the real message is that the global oil supply fundamentals that exist today suggest that U.S. drilling activity will need to decline in 2013."

The number of rigs at work is just one factor that influences oil and gas production in a given year -- things like well decline rates, cycle times (the amount of time between well spud to its completion), the number of wells awaiting completion, the timing of when during a year most wells are drilled, pad drilling, and weather also affect annual production -- but the ratio of total production to average rig count since 1988 yields some interesting results. Namely, average crude oil production per oil rig continues to decline, while average natural gas production per gas rig has improved in recent years.

The amount of crude oil produced per oil rig has fallen every year but one since that ratio reached 91.8 Bcfe per rig in 2002. In fact, that ratio plummeted to just 12.6 Bcfe in 2011, the lowest year on record since Baker Hughes began compiling the complete annual rig count data in 1988. Meanwhile, natural gas production per gas rig actually improved to a range of 23.8-27.3 Bcfe per rig between 2009-2011, up from a range of 13.8-14.2 Bcfe per rig from 2006-2008. In short, exploration and production companies have been producing more gas with fewer rigs.

The Raymond James analysts' initial forecast is that total domestic drilling activity in the coming year may need to decline by around 10%, or about 250 rigs, from the beginning to the end of 2013. They still expect the second half of this year to show "strong growth as the rate of decline in gas activity slows relative to the rate of improvement in oil activity."

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