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Here's Why These Oil and Gas Stocks Were Down As Much As 24.7% in May

By Maxx Chatsko – Jun 6, 2017 at 1:53PM

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Crude oil and natural gas prices dropped 5% in the last week of the month, as traders fears too much production will spoil a long-term rebound.

What happened

Many American oil and gas companies saw their stocks decline by double digits in the last 10 days of last month, as petroleum prices declined across board following weeks of steady gains. One reason: Analysts thought OPEC would commit to a larger production cut than the one originally announced, at "only" 1.8 million barrels per day. Shale production has been booming to start off 2017, as evidenced by just about every company's first-quarter earnings announced in late April and early May, which has traders concerned that the world will have too much supply without further production reductions from... somewhere.

Shareholders of Halcon Resources (HK), Range Resources (RRC 0.12%), Carrizo Oil & Gas (CRZO), Southwestern Energy Company (SWN), and SM Energy (SM -1.43%) all stomached double-digit stock losses in May as a result of the market's jitters. Yet while both crude oil prices and natural gas prices declined in the last week of the month, all five companies have demonstrated significantly improved performance compared to the year-ago period. In fact, all posted quarterly profits for the first time in over a year.

Will the party be short-lived?

Piping equipment ready to be put to good use in a shale well.

Image source: Getty Images.

So what

Maybe not. The price war started by OPEC in 2014 has had the opposite effect that was intended. Rather than drive American shale producers out of the market, it has made them more resilient as various new technologies (multilateral drilling, simultaneous operations, micro-seismic, water flooding, and the like) have driven down production costs in the past 36 months. In the book The Absent Superpower, geopolitical strategist Peter Zeihan makes the case that a combination of new technologies could push production costs to $25 per barrel by 2019 in the four major shale plays -- on par with low-cost Saudi oil fields.

That would mean American shale production is here to stay. And rather than simply swiping the former largest importer of crude oil off the market, the new economies of shale could allow producers to gradually ramp up exports to more directly impact OPEC revenue streams.

That would also explain the pessimism around these companies, which aren't major players in the lowest-cost fields. Halcon Resources, Carrizo Oil & Gas, and SM Energy each own marginal acreage in the low-cost Permian, with substantially more holdings in higher-cost plays. 

For instance, Halcon Resources ended the first quarter with 82% of its production coming from the Williston Basin (including Bakken and Three Forks) and just 2.4% of production coming from newer assets in the Delaware Basin (part of the Permian). Likewise, Carrizo and SM Energy generated just 3.8% and 28.7% of their respective production from the Permian Basin, although the latter is gas-heavy. Simply put, Wall Street isn't taking a lack of exposure to the Permian lightly.   

HK Chart

HK data by YCharts

Meanwhile, gas-heavy Southwestern Energy Company and Range Resources (and even SM Energy) didn't fare well with a drop in natural gas prices, as Henry Hub fell roughly 5% in the last week of May. However, investors should know that natural gas prices are more insulated from global shocks. More importantly, prices for natural gas and associated liquids are significantly higher now than at the same time last year, which bodes well for 2017 performance. Southwestern reported gross profit of $595 million in the first quarter of 2017, compared to just $383 million in the year-ago period. Similarly, Range Resources bested its first-quarter 2016 gross profit by 192%. 

Given that these companies turned their first quarterly profits this year in quite some time, though, Wall Street's knee-jerk reaction to energy market movements is at least somewhat understandable.

Now what

American shale energy production is definitely here to stay, but that doesn't mean all producers are created equal. Those with smaller exposure to the lowest cost shale plays will find themselves most at risk from market volatility for sudden price drops, as was witnessed at the end of May. The somewhat good news is that production costs will continue to be driven lower in the next few years for all formations, although these companies must earn their lower-cost production with a steady stream of capital expenditures.

Maxx Chatsko has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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