Here's why the rig count matters

The US oil rig count may be at a turning point.

The weekly tally provided by driller Baker Hughes has climbed for two straight weeks, after falling for 25 straight weeks, as drillers suffered from the crash in oil prices.

In a note Wednesday, UBS’ Maury Harris points out how the plunge in the rig count impacted the economy in the first quarter.

In Q1, the component of US gross domestic product (GDP) that factors in oil mining and exploration took out a full half a percentage point from growth in the first quarter. See the chart below.

Harris establishes that the rig count is a key indicator of the energy sector’s contribution to economic growth; investment in mining, exploration, and shafts feed into GDP, and closely tracks the rig count.

Harris also notes, as evidence of some improvement, that employment numbers from Challenger, Grey and Christmas show that the number of job cuts in oil and gas exploration fell to 7,563 in Q2 after averaging 12,604 in Q1. And in June, West Texas Intermediate crude futures crossed $US60 per barrel — a level that Goldman Sachs analysts said was comfortable for drillers to raise production again.

Morgan Stanley analysts nailed their forecast that the rig count would turn positive about 26 weeks from when drillers decided to take equipment offline. Their research, published in April, showed that’s roughly how long a turnaround took in the last four major rig count plunges.

Right now, economists are betting that growth in the second half will be better than the first. In Q1, when poor weather, weak consumer spending, and a host of other factors contributed to a gross domestic product reading of -0.2%.

And so, over the next few weeks, the oil rig count will indicate, in a small way, just how much of a rebound we’ll see.

Here’s Harris:

“Although the rig count initially appeared to be stabilizing in early July, that does not necessarily rule out a further energy exploration-related subtraction from Q315 real GDP growth. In 2009, the rig count stabilised in Q3 but the energy exploration component of real GDP continued to decline that quarter. However, it fell at only around half the pace of the first two quarters of the year, when the rig count was tumbling and subtracting, on average, around ½ percentage point from H109 annualized real GDP growth. Something similar could occur in the current setting. While the rig count has at least temporarily stopped falling, through mid-July, it remained somewhat lower than its 907-unit average level of the previous quarter.”

This chart shows the contribution of oil drilling activity to GDP.

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