Oil Hasn't Recovered Yet, And The Proof Is In The Rigs

The most recent Baker Hughes rig counts last week showed a week-over-week increase of 19 U.S. rigs and 8 Canadian rigs. However, Morgan Stanley analyst Adam Longston argues that oil investors should take little comfort in rising rig numbers.

Lagging Indicator

According to a new Morgan Stanley report, the recent uptick in rig counts has nothing to do with the current U.S. oil supply and cost structure. Longston points out that rig counts tend to lag oil prices by up to five months, and he believes that the most recent rig count numbers are nothing more than a reflection of the short-lived oil price spike that sent WTI prices above $60/bbl earlier this year.

Related Link: Oil's Next Act: Transportation

Productivity Lag

Because the lag between crude prices and production levels is typically at least six months, Longston argues that the recent slump in crude prices essentially guarantees that U.S. production will fall throughout the rest of 2015. The slight bump in rig counts in July will have no effect on this decline.

In addition to pointing out the backward-looking nature of rig counts, Longston also explains that, after declining by more than 1000 rigs in one year, a bounce of a couple dozen rigs over a handful of weeks is essentially nothing more than noise when it comes to long-term forecasts.

Outlook

While service costs have fallen significantly, Longston doesn’t see current oil prices anywhere near where they need to be to support U.S. production.

“Most producers need $70/bbl 12-24 months out before adding rigs, even with 20-30% service cost reductions,” he explained.

Shares of the United States Oil Fund ETF USO remain down more than 20 percent in 2015 and down 55.9 percent over the past year.