The oil market has seen a sharp rise in prices last week, but it still below $50 per barrel. The recent developments in the oil market could suggest high volatility in prices in the near term and a potential rally in the second half of 2015. Let’s review the recent developments in oil and reexamine the Hotelling model and its view on the current low oil prices.
The US oil market is starting to adjust to the low oil environment by reducing the number of rigs. The EIA estimated that offshore drilling costs, on average, around $51 per barrel, while onshore drilling is roughly $31 per barrel. This is a $20 gap. Considering the current price of oil is close to $50 per barrel, this is the difference between turning a profit and not.
Since the offshore drilling tends to be more expansive than land drilling, one would expect a sharper fall in offshore rigs compared to onshore rigs. But this isn’t the case.
At face value, however, it doesn’t seem that US oil producers have focused on cutting down offshore oil rigs over onshore rigs. Based on the latest report from Baker Hughes, the number of total US rigs has dropped by 20% since the end of September – back when oil prices were above $90. This is based on a 20% drop in land rigs and 21% decline in offshore rigs. So the drop in number of rigs was similar in both the onshore and offshore.
The rest of this analysis is at Seeking Alpha
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