Are Crude Oil Prices Related to the Rig Count?

Oil rig count lower for seven consecutive weeks

Crude oil production has dipped by 8.1% from its peak. On May 6, 2016, crude oil prices were ~59% below their highs on June 20, 2014. Since then, crude oil prices started to fall due to oversupply. The US oil rig count fell for seven consecutive weeks, according to data released by Baker Hughes (BHI) on May 6, 2016.

Rig count and crude oil prices

Over the last ten years, the oil rig count and crude oil price bottoms have been between three to four months apart, according to research from Morgan Stanley. After the sub-prime crisis, when crude oil (USO) (UWTI) (SCO) touched multiyear lows in January 2009, the rig count bottomed out in May 2009. If this timeframe applied today, the rig count number should hit its bottom by June 2016. Crude oil (OIL) touched a 12-year low on February 11, 2016, before rebounding 68.6% as of May 11.

Why the rig count is important to oil-weighted stocks

Upstream companies’ reduction in capital expenditure is directly reflected in the rig count fall. This has just started to show in US crude oil production, which has dropped ~5.9% since its peak of 9.7 MMbpd in April 2015. If the rig count bottoms out and starts to rise again, it will be an indication that upstream companies are starting to increase drilling activity again, which could eventually result in higher crude oil production. This will weigh on crude oil prices and could be an important factor for oil-weighted stocks such as Synergy Resources (SYRG), Carrizo Oil & Gas (CRZO), Bonanza Creek Energy (BCEI), and Halcón Resources (HK).

What’s the Correlation between Crude Oil Inventories and Prices?

Last week’s data

US commercial crude oil (USO) (UWTI) (SCO) (UCO) (BNO) inventories rose by 2.8 million barrels compared to the previous week. Inventories were at 543.4 million barrels for the week ended April 29, 2016. US  crude oil inventories are at historically high levels, according to data released by the EIA (U.S. Energy Information Administration) on May 4, 2016. The EIA will release inventory data for the week ended May 6 on Wednesday, May 11.

Correlation of crude oil inventories and prices

Between September 2007 and June 2011, crude oil futures rose. During this period, the four-week correlation between crude oil inventories and prices was negative. The negative correlation clearly indicates that a drop in inventory levels broadly drives a rise in crude oil futures, and vice versa.

However, between March 2011 and September 2014, the correlation was more bi-directional. So, other factors like excess liquidity and data missing market expectations could be other important factors driving prices, apart from simple demand-supply dynamics in the oil market. Between September 2014 and March 2016, the correlation was negative. During this period, crude oil was in a downturn, which was an indication of how rising inventories have been helping push crude oil prices lower.

Currently, the correlation in the four weeks to May 4, 2016, is at 27%, and crude oil inventories are at historical highs. Over this period, crude oil moved upward despite rising inventories. The reason could be that inventory figures have already been discounted in crude oil prices. The above analysis could be important for oil-weighted stocks such as Concho Resources (CXO), Halcon Resources (HK), Synergy Resources (SYRG), and Kosmos Energy (KOS).

What’s the Correlation between Crude Oil and the Dollar Index?

Correlation of crude oil and the dollar index since 2007

Between September 2007 and April 2013, the crude oil (USO) and dollar index (UUP) one-month correlation was positive in only a few instances. The correlation coefficient was largely negative for these five and a half years. After the sub-prime crisis, crude oil futures extended their gains and made highs of $113.93 and $109.77 in April 2011 and February 2012, respectively.

Crude oil’s negative correlation with the dollar index between September 2007 and April 2013 clearly implies that crude oil had a close relationship with the dollar index. However, since April 2013 to date, the one-month correlation has been more bi-directional. In the last three years, the one-month correlation has fluctuated between -64% and 43%. This fluctuation could indicate fundamental drivers like Saudi Arabia’s decision not to cut production, US shale oil producers’ cost and production dynamics, US inventory data, and other fundamental news that has had a greater impact on crude oil compared to the dollar.

Crude oil and the dollar index over the last six trading sessions

In the last six trading sessions, crude oil gained about 2.3% in spite of the fact that the dollar index also rallied around 1.4%. The factors that impacted crude oil futures have already been discussed in part one of this series. As discussed earlier, crude oil movement in the current scenario was more fueled by mainstream news than the dollar index was.

Oil-weighted stocks and ETFs

The above analysis is important for oil-weighted stocks such as Abraxas Petroleum (AXAS), Triangle Petroleum (TPLM), and Denbury Resources (DNR). The Direxion Daily Energy Bear 3X ETF (ERY), the First Trust Energy AlphaDEX ETF (FXN), the United States Brent Oil Fund (BNO), and the United States Oil Fund (USO) are also impacted by the correlation of crude oil with the US Dollar Index.

Market Realist