What happened
Oil prices sold off sharply this week, ending down about 6%, to right around $46 per barrel. That sell-off pushed crude down to a five-month low -- and back to where prices were when OPEC announced its output cuts. Driving down crude is the continued rise of U.S. oil supplies, which have increased 11 straight weeks thanks to surging shale production.
Making matters worse, several oil stocks reported first-quarter results this week that were poorly received, giving investors more reason to sell. Leading the downdraft, according to data from S&P Global Market Intelligence, were Unit Corp. (UNT +0.00%), Pengrowth Energy (NYSE: PGH), Denbury Resources (DNR +0.00%), Emerge Energy Services (NYSE: EMES), and U.S. Silica Holdings (SLCA +0.00%).
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So what
Diversified energy company Unit Corp. sold off after its first-quarter earnings missed expectations by a wide mark. After adjusting for one-time items, Unit earned $7.5 million, or $0.15 per share for the quarter, which was $0.09 per share below the consensus estimate. One of the culprits was production, which only averaged 42,000 barrels of oil equivalent per day (BOE/D), a decline of 15% year over year and 8% from just last quarter. Three factors drove that decline: an underinvestment in new wells, the shut-in of several wells because of maintenance at a third-party processing plant, and some weather-related issues. Another concern weighing on the stock this week is that slumping oil prices might force the company to cut back on drilling later this year, which could derail Unit's plans to start growing production again.
Pengrowth Energy also plunged after reporting first-quarter results, though the Canadian oil and gas producer did beat expectations. Furthermore, over the past few months the company has announced several asset sales, which have significantly improved its financial situation. That said, Pengrowth's output continues to sink due to underinvestment, and will likely keep heading lower for the foreseeable future, thanks to the recent string of asset sales and the company's current inability to invest in new growth projects because of creditor restrictions. While Pengrowth is having discussions with lenders so it can move forward with a new expansion phase, slumping crude prices could put the brakes on those plans.
Denbury Resources also reported declining output in the first quarter due to underinvestment, which when combined with higher-than-expected costs, caused the company to miss expectations. While Denbury, like Unit Corp., anticipates reversing its output slide later this year, the recent slump in oil prices has the market questioning whether that's an achievable goal.
Finally, frack-sand producer Emerge Energy Services reported a wider-than-expected loss this week, causing its stock to sink, and taking rival U.S. Silica down with it. The concern is that Emerge Energy Services still hasn't returned to profitability despite delivering 51% higher volumes during the first quarter. That's a worry because there's a growing possibility that volume growth for frack-sand producers could slow down later this year due to slumping crude prices. That said, analysts at Stifel remain optimistic that Emerge Energy will turn the corner next quarter and report the first quarter of positive EBITDA (earnings before interest, taxes, depreciation, and amortization) since the end of 2015; Stifel upgraded the stock from hold to buy and increased its price target from $14 to $16. The market, however, isn't yet buying this optimism, given that crude remains on a slippery slope.
Now what
Despite a better oil market for most of this year, some oil stocks are still struggling due to their weaker positions both financially and within their resource base; if crude doesn't bounce back soon, these stocks could continue to slide. Investors should avoid weaker oil stocks at all costs right now, and instead only invest in those with stronger balance sheets and resource positions, because they're better equipped to ride out the market's volatility.
