DEFINITION of 'Day Rate (Oil Drilling)'

 

Day rate refers to all in daily costs of renting a drilling rig. The operator of a drilling project pays a day rate to the drilling contractor who provides the rig, the drilling personnel and other incidentals. The oil companies and the drilling contractors usually agree on a flat fee per contract, so the day rate is determined by dividing the total value of the contract by the number of days in the contract. Day rate fluctuations, which can be wide, are used by investors as an indicator of the health of the drilling market. For example, if day rates fall, investors may take it as a sign to exit oil and gas positions.

BREAKING DOWN 'Day Rate (Oil Drilling)'

 

Day rate is one of a number of drilling rig based metrics that investors in the oil and gas industry watch to evaluate the overall health. The day rate makes up roughly half the cost of a well. Of course, the price of oil is the most important metric by far in the oil and gas industry. That said, investors can gain insights into the petroleum supply and demand picture by watching metrics like day rate and rig utilization in addition to global inventories.

Day Rate and Oil Prices

Day rates in oil drilling are positively correlated with oil prices. This is common sense, as an increase in the price of oil increases the number of projects that can recover their extraction costs, making difficult formations and unconventional oil reserves feasible to extract. The more projects green lighted on an economic basis, the more competition there is for the finite number of oil rigs available for rent - so the day rate rises. When oil prices waver and fall, the day rate that rigs can command drops.

The strength of the correlation between oil prices and day rates is not consistent. The correlation is strong when oil prices and rig utilization are both high. In this situation, day rates increase almost in lock step with prices. In an environment of rising oil prices and high utilization, the day rates in a long term contract will shoot up even faster than short term contracts as rig operators demand a premium for being locked-in on a project. In a low price environment with falling utilization, however, the day rate may plunge much faster than the oil prices as rigs enter low bids on long contracts just to keep busy in a potential slowdown. Due to the volatility and the varying strength of the correlation, investors and traders can flip between seeing day rates as a leading or a lagging indicator for oil prices and the health of the oil and gas industry as a whole.

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