The oil market is finally starting to make sense

Companies that provide oil and gas drilling services had to lower prices for their clients during the most recent oil crash.

Some oil-field services providers lowered prices for offshore drilling by as much as 50%, toward levels that would have made their businesses unprofitable, according to Reuters.

Drilling prices, however, are starting to stabilize and recover.

“It appears that the pricing for drilling oil and gas wells has begun to rationalize,” John LaForge, the head of real asset strategy at Wells Fargo Investment Institute, said in a recent note.

The producer price index for well-drilling costs, which measures cost changes for producers, jumped 8.7% in February from the prior month, the biggest monthly increase since 2005. Prices spiked on an annual basis too, by the most since August 2014.

“We do not believe that it foretells higher or lower oil prices in the next few months,” LaForge said. “It does, however, give us another piece of evidence that the oil markets have structurally begun to balance, after years of being out of whack.”

Wells Fargo Investment Institute

Oil-field services giants like Baker Hughes and Halliburton lost pricing power because the oil crash hurt their clients’ revenue. That fiscal pain led clients to be more willing to find the cheapest driller.

Separate from the oil crash, there has been a structural decline in the average cost of drilling for oil for the past few years. According to a report from the Energy Information Administration last March, costs per well increased from 2006 through 2012 — a time of rapid growth in US drilling activity. But average costs have fallen since 2012 partly because of more efficient technology.

Oil drillers are seeing growing demand for their facilities. The Baker Hughes tally of oil rigs has climbed for the past 11 weeks, reflecting more confidence in the oil market as prices stabilize near $50 a barrel.

“Oil prices look to have entered Phase 2 of the commodity bear super-cycle; low and range-bound price action ($30 – $60), as the market recalibrates,” LaForge said. “Phase 1, by the way, was represented by crashing prices, like what we saw between 2014 and 2016.”

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