The Day The Drilling Industry Fell Off A Cliff

We’re coming up on the five-year anniversary of the market meltdown in fall 2008. Let’s get specific to energy and look at one key aspect of the crash.

In particular, let’s review what happened with oil – there are a few investment lessons I think you should know…

Things were manic in many markets through summer 2008. Oil offers an extreme example of the melt-up mania that preceded the subsequent crash. In fact, oil prices exceeded $140 per barrel in July 2008.

The ripples of pricey oil spread far. In many parts of the U.S., gasoline prices topped $5 per gallon and even $6 per gallon in some locales. I recall looking into the summer sky and thinking that every passing airliner was losing money due to high fuel costs.

The five-year price chart for Brent crude illustrates the point. You can clearly see the pre-crash summer run-up in oil prices.

Then, in the last quarter of 2008, the deluge came. Markets crashed. Share values dove. Prices unwound for everything, including oil. Look at the Brent price chart above. By early 2009, oil was trading in the $40 range per barrel. It was a $100 drop.

Looking back, I recall attending an energy conference in South Africa in October 2008. One attendee was Scott Tinker, state geologist of Texas. Scott is a third-generation oilman and a professor of geology at the University of Texas. He knows a few things about the energy biz.

During the conference, Scott and I talked about what was occurring across the oil and oil service industry. Markets and pricing were unwinding before our eyes. “Watch out,” said Scott. “With this kind of market crash, we’re sure to see a decline in drilling. Then the next question will be what happens to overall U.S. energy production.”

Sure enough, in early 2009, the number of drilling rigs working in North America plunged. Here’s a five-year chart for oil and gas rigs, based on data from the highly regarded Baker Hughes (BHI) rig count. You can see the precipitous 50% drop in rig counts during early 2009. It’s like the drilling industry just fell off a cliff.

Recovering Prices, Rig Count and Output

“A great princess falls, but doth not die,” wrote the poet John Donne. So it is with the queen of fossil fuels, petroleum. And as the first chart above shows, by early 2009, oil prices began to recover. Then, as the Baker Hughes rig count chart above shows, oil and gas drilling soon picked up in North America.

You can see from these two charts that oil rig utilization tracked along, more or less, with the rising oil price to about mid-2012, when both prices and rig counts hit a plateau.

Also of interest, though, note how the count for natural gas rigs recovered slightly in 2009 and 2010. But then the gas-drilling numbers flattened out. When it comes to natgas drilling, the rig count has declined continuously for the past two years. That’s the North American gas glut at work.

Go back to Scott Tinker’s concern in late 2008. What happened with U.S. oil output after the autumn market and oil price crash? The 2009 oil price recovery accelerated drilling. Then, something astonishing occurred. Indeed, to gain better perspective, let’s look at the U.S. crude oil production numbers over the last 25 years.

We had a long, steady decline in U.S. oil output through the 1990s. It reflected low oil prices and long-term depletion. The flat period from 2005-08 was due to somewhat more drilling as oil prices spiked into the 2008 run-up, but with no real corresponding increase in output. Those few years reflect a drilling treadmill of sorts, during which U.S. oil output held steady, but didn’t grow.

And then? After the 2008 crash and into the price and drilling rig recovery of 2009, U.S. oil production began a quick, steep rise. You can pretty much place your finger right on the time frame when things turned around in the U.S. (and Canadian) oil patch. It was the winter of 2008-09. What happened? Several things.

Prices matter, to be sure. The post-crash oil price turnaround instantly stimulated the nation’s oil operators to drill more wells. Higher prices attract investment.

Indeed, something unexpected happened in the 2008-09 timeframe, too.

But, we’ll save that part of the story for tomorrow. I’ll stop back in with the full story on American oil’s big turnaround – plus, five years later, which companies are still set to benefit.

Thanks for reading.

Byron King
Original article posted on Daily Resource Hunter