Why Oil Drilling Stocks Are Gushing Higher Today

What happened?

A lot of oil stocks are surging today, with one category -- oil drillers -- seeing some of the biggest gains. As of 1:56 p.m. EDT on Friday, the SPDR S&P 500 ETF Trust (SPY 0.95%) was up 2.8%, but companies involved in both offshore and on-land oil and gas drilling were rocketing much higher:

*As of 1:56 p.m. EDT. Source: YCharts.

So what

Two things are sending many oil stocks higher today. First, the entire market is on a big run higher on positive jobs news. U.S. employers added 2.5 million jobs to their payrolls in May, a signal that the economy could recover quickly from the coronavirus lockdown recession, which would boost demand for oil that has fallen more than 20% over the past three months. 

Investors are hopeful more oil drilling rigs are set to go back to work. Image source: Getty Images.

In addition to the prospects for an economic recovery helping oil companies, investors think drillers in particular are facing potentially much better prospects now than they were even a month ago. Oil producers have slashed spending to survive the collapse in demand and prices, and all those spending cuts could lead to an undersupply of oil later this year. That's a huge turn from the current market, which is still oversupplied. 

A large number of the jobs added in May were to businesses that require people to commute, such as restaurants and retailers. This is a positive for oil demand, which has cratered, and helps to alleviate (at least temporarily) concerns that the coronavirus could cause a lasting shift in work away from offices, permanently reducing the potential for oil to fully recover. 

But the bigger news that's helping lift optimism for oil drillers is that OPEC+ is expected to agree to keep current production levels in place for at least another month. This stability in global oil markets is crucial to keeping crude prices on their monthlong upward trajectory. 

Now what

Let's circle this back around to companies that provide drilling services for oil and gas producers. There are two very different groups: Offshore drillers like Seadrill, Transocean, and Valaris, and onshore drillers like Helmerich & Payne, Nabors, and Patterson-UTI. Simply put, their prospects are very different. 

U.S. onshore drilling activity has absolutely crashed this year. At last count, 284 onshore rigs were operating, down 71% from last year. If the economy does indeed come roaring back, all this cutting could realistically result in a quick shift from the current oversupplied market to undersupply, pushing prices up and increasing demand for drilling activity very quickly. This would be a boon for onshore drillers due to the dynamics of shale production. Shale oil can go from initial drilling to producing oil within weeks. 

Offshore, the dynamics are very different; much of the oil offshore is found in deep water, very deep underground, and often in harsh conditions. The result is a very long development cycle (think years, and even decades, versus weeks) that changes how oil producers approach investment in offshore. 

Add it all up, and the prospects for offshore drillers remain very poor. 

What about onshore drillers? We may be seeing the bottom for U.S. rig activity, and it's possible drilling does start to recover soon. But I think it's still too soon to say the worst is over for onshore oil, and that it's only going to be good times from here. There are still more than 20 million Americans out of work, and the unemployment rate is still above 13%. 

There has also been very little progress made on COVID-19. Cases are on the rise in some places that have opened up their economies, and another wave could erase much of the economic progress we have seen that's helping buoy the oil market. The bottom line: The U.S. oil patch is still a mess, oil companies continue to sit on the limited capital they have for now, and international producers aren't planning to increase their output (and hence, spending for drilling activity) anytime soon, either.

That will continue to put pressure on drillers, both offshore and onshore, for the foreseeable future. The rally in their stocks is nice if you own shares, but the risks remain pretty high for the entire subsector.