Rig counts in the U.S. are back down to July, 2005 levels as crude oil prices have dropped back to the $40 range.

Baker Hughes (BHI: chart, web, Y!) has issued the rotary rig counts as a service to the petroleum industry since 1944, when Hughes Tool Company (of Howard Hughes fame) began weekly counts of US and Canadian drilling activity.

The rig count acts as a barometer for the drilling industry and its suppliers.  In effect, the more drilling rigs out making holes in the ground, the more is being spent on exploration, leaving one to believe that the industry believe oil prices justify drilling for more production.

As of last Friday (rig counts are updated at noon on the last day of the work week) the US rig count was down by 73 rigs with a total of 1,399 rotary rigs actively drilling.  Of those, 283 are being used in drilling exclusively for crude oil.

That compares to data from back in July, 2005, when 1,404 rigs were working, but at that time the count was steadily increasing.

This data indicates that the oil and gas industry doesn’t see crude oil prices rising substantially any time soon, so as not to increase capital expenditures to increase production.  In fact, most analysts are expecting a production cut by OPEC at the next meeting in March.

As for natural gas…

Baker Hughes also publishes the number of rigs used in drilling for natural gas.  That number dropped this week by 46 to 1,104 rigs.

Directional drilling has declined also, which isn’t surprising.  The cost of drilling a horizontal well is far greater than drilling a conventional straight bore well.  In this environment, there’s no point in spending top dollar only to have to shut in production due to poor economics.

Corner Office Comments

I believe crude oil will continue to trade in a $40 to $50 range for the next several months, with an occasional but short lived dip below $40.

OPEC will most certainly cut production in March, but to what effect those cuts will have on market prices for crude is uncertain.  The market has not reacted in like kind in the past, and I suspect it won’t care much about OPEC cuts this go ’round either.

Oil & Gas Baker Hughes, BHI, oil and gas, rig count

Have you noticed prices at the pump lately? In my area, gas went from $1.39 per gallon to $1.79, even while crude oil prices are floundering below $40 per barrel.

There seems to be a significant divergence of crude oil prices as compared to gasoline, and it’s indicative of a shift between demand for crude oil and production output of refined products.

Refiners margins have been down recently due to the drop in crude oil. During the fourth quarter of last year, the price of a barrel of crude oil was actually more expensive than a barrel of unleaded gasoline (remember there are 42 gallons in a barrel). That meant that the refineries were paying more for the raw material than they were selling their product for. Hence, the drop in refiner stocks, such as Valero (VLO: chart, web, Y!) and Tesoro (TSO: chart, web, Y!).

Now that oil prices have started to stabilize around $40 per barrel, and refiners have taken delivery of their crude purchased for much higher prices, they’re starting to increase their margins by cutting production.

In the first week of January, refined gasoline totaled 9.1 million barrels per day.  By the end of the second week of January, total production was 8.8 million barrels per day, a 300,000 barrel per day drop in refined products.

Demand has been dropping for the last three weeks, and demand on January 9th hit 8.75 million barrels per day.  So production is just keeping up with demand, and no more.

Gas prices typically lag crude prices by a month; two depending on how futures contracts play out.

Corner Office Commentary

If oil prices continue to trade between 35$ and $40 per barrel for the next two months, I would expect gasoline prices to start to turn the corner and head down at the beginning of February.

The change in refined product output should run its course by the end of this month, so long as more output cuts are foregone.  Even then, once the refiners build margin back into their books, we should see gas prices stabilize.

Oil & Gas gas prices, gasoline, oil and gas, oil prices, refinery, Tesoro, TSO, Valero, VLO

Last week Provident Energy Trust (PVX: chart, web, Y!) announced that while they had successfully closed the sale of their U.S. oil and gas business, they would also be cutting the monthly dividend to $0.09 Canadian, or about $0.07 USD.

Although that certainly smarts, I can’t say that I’m surprised.

Provident has traditionally been a very conservatively managed trust.  They look to increase their reserves with the smallest amount of risk (i.e. expanding production through infield drilling and acquiring proven reserves), and they really don’t take off any more than they can manage, and manage well.  A case in point was the divestiture of its equity interest in BreitBurn Energy Company L.P for a total sale of about $305 million USD.

Provident has been beaten down lately with the rest of the markets, commodities in particular.  As fast as oil prices rose, they fell even faster.  I suspect that the price action from most Canadian trusts came as a result of big money fleeing the market to increase liquidity, and money was pulled from even the most attractive places.  No stock is/was safe.

The good news behind all this is that fundamentally the trust looks fairly robust.  Funds flow from operations in Q3 were up 44% from the same quarter of last year.  Production from the Canadian side of the O&G business was up just slightly (~1%) from the same quarter year over year.

Interestingly, the payout ratio was down to 61% for the third quarter, as compared to 89% from Q3 last year.  For the nine months ended September 30, the POR was just 53% compared to 88% for the same period last year.

So why the dividend cut?

Just like any business in this economic climate, PVX is facing the same pressure economically as the mid-majors in the U.S.  The forecast for oil prices in the next 6 to 12 months is anyone’s guess, and while things were looking up as of the end of the third quarter, they aren’t so bright going into Q4, and I suspect the results from this quarter, reported next year, will be less than palatable.

Provident believes that capital spending must be aligned with prevailing economic conditions. To this end, the Board of Directors has adopted a conservative capital budget of $165 million. Provident has an extensive inventory of quality opportunities available for additional investment. Provident will review its capital program throughout 2009 to determine whether any combination of work program results, commodity prices, equity and debt market conditions or other material factors merit changes to the capital budget. -Source

It’s clear that Provident is getting a head start on the budgetary aspects of this downturn in the oil and gas industry, however I believe that they are savvy enough to capitalize on these bad times. In a lot of respects, they already have.

The company has a new development they’re calling the Pekisko play in Northwest Alberta, consisting of a 100% working interest in about 54,000 acres of undeveloped land.  What’s interesting about this is that that acreage is right next to existing company operations.  So they know the geology and they know the local reserves.

In fact, they drilled two horizontal exploratory wells that production tested more than 250 bpd.  Not bad, even for $50 oil.  In all, the reserves are estimated at 2 million barrels of proved plus probable oil based on these two offset wells.  In all the company has about 300 drilling locations in the play, so they’ll be busy for a while.

In all, I’m not really worried about my stake in PVX, sure the distribution cut is a bummer, but again I’m not surprised.  The potential that keeps presenting itself to the company is still attractive, and the fact that they capitalize on their opportunities is a sign of a well-run oil and gas company, regardless of the market or industry conditions.

I look for oil prices to hover between $40 and $60 for about the next six months or so, and then go up as the economic conditions strengthen.

Energy, Investing, Oil & Gas, Royalty Trusts Candadian Oil and Gas Trusts, dividends, DRIP's, oil, PVX