Will the irresistable oil and gas recovery be able to overcome the immovable object of commodity prices? We will know soon, as early as the first quarter of 2017.

It seems as if the recovery in oil and gas activity, like June, is busting out all over. The horizontal rig count, a proxy for tight formation exploration and development, was up 24% in November versus the historic low in May 2016.

The recovery began with private equity- backed independents that were first out of the gate at the beginning of the third quarter. Privately held independents represented 44% of rig activity in November vs. 38% in June. The rebound entered a second phase as the fourth quarter began, with publicly held companies announcing plans to add incremental rigs in 2017.

For the most part, those announcements amounted to one or two rig additions, nothing earth-shaking on an individual basis. But the numbers are material in aggregate. The rig count could rise 100 units during the first half of 2017 as new budget money becomes available, easily matching the pace set in the second half of 2016.

The budget philosophy for 2017 suggests a momentum shift from the supply chain side of corporate management and its relentless focus on reducing costs back toward the engineering and production side.

For the recovery to develop traction, it must be broad-based. A growing list of drilling hot spots indicates expansion is underway. New understanding of the Mississippian play in the Anadarko Basin is reflected in increasing activity to delineate the extent of the Meramec/Stack. Delineation drilling is continuing in Cretaceous- aged shales in Colorado’s North Park and Wyoming’s Powder River basins. Similarly, Apache Corp. is prospecting Mississippian and Devonian-aged targets atop the Alpine High in the southern Delaware Basin.

Nor is expansion confined to oil basins. Chesapeake Energy Corp. and a handful of private independents are experimenting with longer laterals and increased proppant loading as a means of reducing unit costs in the Haynesville Shale and the Cotton Valley, while the Marcellus Shale has seen a steady rise in activity during the fourth quarter, even as natural gas prices lose steam.

Signs of recovery are also evident in the uptick in A&D activity. The land grab continues in the Delaware Basin as private independents sell out at astronomical peracre prices to larger public firms or new private equity-backed management teams. Those acquisitions—more than $20 billion year-to-date in the Permian Basin—presage spending on field activity as the investors underwriting acquisitions compel operators to move forward on programs.

Capital efficiency improvements are likewise stimulating a recovery. Rig costs have become almost immaterial as longer laterals, drilled in fewer days, lower the cost per foot of new wells.

On the completion side, roughly half of the savings in capital efficiency have come organically via process improvement. The remainder has been extracted from oil service providers in the form of catastrophic price reductions. Operators may be economic in a $40 per barrel oil world, but those economics have depended on depressed service sector pricing.

Oil service providers have been substituting cannibalization of existing equipment for depreciation and maintenance capital. That disinvestment is not a sustainable business model going forward, and there is general understanding that completion costs will rise as demand increases. The rate at which those costs rise will determine the arc at which the recovery continues.

Completion costs are already escalating in select basins as operators pursue larger proppant loading across longer laterals and increased stage counts.

Service companies need positive cash flow to add capacity and hire employees. If demand for services jumps quickly, the industry will hit a wall, with the ensuing scramble for equipment and crews destined to create a price spike for services. But if commodity prices remain depressed, any service cost increases could impact the sustainability of the current recovery.

November’s OPEC meeting was expected to decide whether or not the organization would embrace production cuts as a means of rebalancing global oil markets. Without production cuts, the industry appears to be in line for another year of oil trading within a band of $40 to $50. For natural gas, weather has been uncooperative heading into the winter heating season.

A recovery appears to be underway, and it appears to be unfolding at a sustainable pace. The industry has come a long way since the bottom, but it still has a long way to go.

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