Publicly Traded Shale Producers Are Gun-Shy, but Small Operators Aren't

The oil booms of 2014 and 2018 were met with a rush of production from large publicly traded operations. In 2021, social and political pressure to go green, towing the OPEC line to keep the peace, and drilling moratoriums, have discouraged production at a time of high growth demand as the economy opens back up. The oil crash of 2020 wiped out some small shale oil producers and left others on the brink of bankruptcy -- what a difference a year makes. Oil Rig Count Private operator oil drillers are now able to access the financing they need to ramp up output in West Texas and southeast New Mexico, and they are expected to do just that. Some analysts believe small producers could make up half of the U.S. production growth next year and with their help, Rystad Energy says the U.S. could be operating at pre-pandemic production levels before the end of the year. To be fair, other research points toward a pre-pandemic production recovery in 2023. Nevertheless, supply is on the way. As an aside, we have also heard a rumor from an insider; ConocoPhillips is looking to go heavy in the basin, in hopes of hiring 50 operators in the next three years. In short, the cure for high prices is high prices. Despite hesitancy from a few well-known U.S. producers, others are eager to ramp things up. Last week's Baker Hughes Oil Rig Count has U.S. rigs at 433, up substantially from the August 2020 low of 172. The rig count has consistently notched higher most weeks in 2021 and is expected to continue. Prior to the OPEC price war in early 2020, the rig count was well above 600. Nearly all of the rig growth has been from private operators for the first time. Sooner rather than later, the added supply will either stabilize prices or cause them to reverse course. In addition to pressure to go green, publicly traded oil producers have been burnt putting their hands too close to the flame. Oil is a boom and bust commodity; for those with inopportune timing in business operations, it can be a painful endeavor. However, the smaller operators that are rushing to come online might not have learned that lesson yet and will be looking to capitalize on high prices to the full extent. Thus, we might not be likely to see oil plunge below $10 again, but a return to the $50s isn't out of the question. Seasonality Although recent years have been less reliable regarding oil seasonality, the 30-year average performance suggests oil struggles to hold gains beyond mid-October. In fact, there is a strong tendency for prolonged selling through the end of the year. Of course, seasonality isn't the holy grail. The market doesn't always behave according to its historical norm but the timing of this rally and the extent to which it has become overbought going into the seasonal peak is something to be aware of. Weekly Chart To tell the oil story, we need to roll the chart back almost to 2012. In the early 2010s, eighty-five to one-hundred-dollar oil was expected. In mid-2012 oil futures fell to $77.00; the market quickly deemed it as being too cheap and bid prices back into triple digits. At the time, the fracking revolution was just getting started. It wasn't until a few years later we learned just how disruptive the new technology would be. Before fracking, a band of support between $84.00 and $77.00 helped to keep prices afloat but in a post-fracking world, the same price band is acting as resistance to rallies. In 2018 the bulls put a valiant effort into breaking through, but ultimately failed; subsequent liquidation cut the price of oil in half to $40.00 per barrel. Three years later, we are giving it a go. And in true 2021 fashion, we managed to break above $80.00 for the first time since late-2014. Nevertheless, there are multiple technical barriers overhead. We have already mentioned the previous support of $84.00, which will now be a headwind for higher prices but there is also a pivot line that begins on the October 2016 low and has acted as resistance on multiple occasions since. Coincidently, this pivot line next next comes into play at $84.00 per barrel. The downtrend line dating back to 2014 and 2015 comes in at $82.00 per barrel. Thus, without a substantial bullish surprise on the fundamental front, we should be witnessing the exhaustion of the move due to sharp resistance at $82.00 and $84.00. If I am wrong about the low-$80.00s holding, the next target would be $90.00. This is unlikely, in my view, but if seen it would be a screaming sell signal. View Chart » View in New Window » With this wide of a lens, we can also see the oil market has a habit of rallying in three waves of price gains but with divergence in the RSI (Relative Strength Index). Divergence occurs when a futures price makes a new high but the oscillator does not -- this pattern is a possible sign of a looming trend reversal. This three-wave divergence pattern occurred prior to the 2014, 2018, and 2019 corrections, and it appears to be happening again. This chart also depicts the market's tendency to sell off in October. In 2014 and 2018 the October selloffs were quite stunning. On the way down, there will be support at $72.00 and again at $62.00. If we break into the $50.00 handle, we will likely see the low $40.00s. Before writing this analysis off, think back to mid-2020 and consider the reaction a call for $80.00 oil might have received. In oil, anything is possible.

Publicly Traded Shale Producers Are Gun-Shy, but Small Operators Aren't

The market doesn't always behave according to its historical norm but the timing of this oil rally and the extent to which it has become overbought going into the seasonal peak is something to be aware of.

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