Now that oil and gas prices are down sharply, rig demand is likely to follow. In the near term — which I would consider under two years in this context — low oil and gas prices will result in diminished drilling activity, particularly in more expensive areas. We can already see in the graphic above that the number of rigs drilling for oil has begun to drop recently after peaking at about 1,600 in October.

But the decline is more pronounced in some areas. Among the major basins in the U.S., the Permian Basin has by far the most drilling rigs, but it also suffered the sharpest decline in rigs in response to lower oil and gas prices:


Over the longer term, oil and gas plays that cost more to produce than the expected price of the commodity will simply not be developed, and if they have been developed they could ultimately be idled if lifting costs exceed the profit margin.

A recent Bloomberg story tells us where projects may be cancelled by identifying the breakeven costs in a number of different shale oil plays, with $80/bbl as a reference point:

Source: Bloomberg New Energy Finance

Note the number of areas in the Permian Basin in West Texas and the Bakken Formation in North Dakota that have break even costs above $70/bbl. Thus, it is not surprising that the biggest drops in drilling activity have taken place in these areas. (Note that “Williston Basin” in the graphic above is where the Bakken is located).

The biggest impact will be on the oil and gas producers in these areas. Occidental Petroleum (NYSE: OXY) and Pioneer Natural Resources (NYSE: PXD) are respectively the #1 and #2 Permian oil producers. Smaller, pure Permian Basin operators include Laredo Petroleum (NYSE: LPI) and Concho Resources (NYSE: CXO).

In the Bakken, Continental Resources (NYSE: CLR) has been the top oil producer, but Whiting Petroleum (NYSE: WLL) is expected to take over that role following its acquisition of Kodiak Oil and Gas. Oasis Petroleum (NYSE: OAS) is a smaller Bakken pure play that could find itself in financial trouble should oil prices remain low.

The reduction in drilling activity will not entirely stop growth in U.S. oil production in 2015, but if the price of oil remains at the current depressed levels over the next year, in 2016 we are likely to see the first production decline in the U.S. since 2007-2008.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

More Gains in Delek’s Pipeline

Delek Logistics (NYSE: DKL) has suffered through a volatile stretch since joining the Conservative Portfolio three months ago, getting off to a strong start before succumbing to the energy sector selloff in November, then clawing its way back to almost even over the last month.

DKL is an even better deal now after announcing last week a new contract for its 195-mile crude pipeline running from northeast Texas to Beaumont on the Gulf coast. The sweetened deal, along with a concurrently announced acquisition of oil trucking assets and planned dropdowns from sponsor Delek Holdings (NYSE: DK) in the near future, will fuel the annual 15% distribution growth rate projected by management without unduly leveraging the balance sheet.

As a downstream logistics provider protected by long-term, indexed contracts with its growing sponsor, DKL should never have been sold down to $30. At its current price it’s still offering a 5.7% yield, or 6.6% based on the projected payout a year from now.

Integrated downstream refining and distribution businesses like Delek’s should thrive on low crude and gasoline prices, which tend to lift retail and wholesale margins. Delek Logistics will benefit from the improved fundamentals as well, and its Gulf pipeline could produce additional value based on continuing talks with shippers. Buy DKL below $42.