A five-component composite leading index of rotary drilling activity for the last thirty-six years is presented. Economic and technical justification are presented showing why each particular component of the leading index should be particular component of the leading index should be expected to lead drilling activity. The leading index has consistently led drilling cycle peaks and troughs by seven months over the thirty-six years studied.
Cyclical behavior in free-market industrialized economies has been present since the industrial revolution. The business cycle or fluctuations in aggregate economic activity have been studied and analyzed in great detail. One predictive tool to forecast cyclical movement is the leading index approach. It has been found that industries or sectors of the economy can be analyzed using the same techniques applied to the macroeconomy. This has been demonstrated in the construction, textiles, and chemical industries. The oil and gas industry, a component of the macroeconomy, will be studied here using the same methods employed for the industries mentioned above drawing on the tremendous body of knowledge compiled on the business cycle. In general economic activity in particular industries is highly correlated with economic activity in the macroeconomy. This will prove to be the case with the petroleum industry.
The leading index approach consists of finding time series which regularly have peaks and troughs which occur before the peaks and troughs, respectively, in economic activity. Leading time series are formed into a leading index. However, some caution must be exercised in choosing which time series to include in the index. Because the number of comparison points is relatively small (11 peaks and 11 troughs in this analysis), it may not be possible to establish statistical significance using, possible to establish statistical significance using, for example, a Student's-T distribution hypothesis test. Therefore it is essential that any time series included in the index be based not only on good historical performance but also on sound economic logic as to why it should exhibit leading behavior.
The advantage of the leading index is that an individual time series usually will not precede all peaks and troughs in drilling activity; a composite peaks and troughs in drilling activity; a composite index will smooth out the perturbations of any individual series, thus yielding much more consistent performance. An excellent example of a leading index performance. An excellent example of a leading index is the U.S. Department of Commerce 12-component leading index of the macroeconomy published in Business Conditions Digest (BCD). A leading index similar to the BCD index will be developed here for oil and gas drilling. Lindlbauer lists the following properties for the ideal leading indicator: properties for the ideal leading indicator:
It should have at least 50 years of historical performance.
It would lead by an invariable interval at both peaks and troughs.
It would have no erratic movements.
The movements would be pronounced enough so peaks and troughs could be unambiguously recognized.
The index would be related to economic activity so that its relationship in the past would remain unchanged in the future.
Achieving these goals is the objective of this research.
The Hughes U.S. rig count is considered by many to be indicative of the overall economic health of the U.S. oil and gas industry.