What happened
Shares of oil-field equipment distribution company NOW Inc (DNOW +0.15%) took a steep dive on Wednesday, falling as much as 11.4% before ultimately closing down 10.9%.
So what
NOW's stock got bludgeoned by a one-two punch on Wednesday. First, crude oil continued coming unglued due to another dose of disappointing government data, falling 2% to around $42.50 per barrel, which slammed shale stocks. While crude oil inventories came down more than expected, the U.S. Energy Information Administration revised its production estimate up by 20,000 barrels per day, driven by shale output that's rising faster than anticipated. For example, just this week Permian Basin driller Parsley Energy (PE +0.00%) revised its 2017 production estimate from 62,000-68,000 barrels of oil equivalent per day (BOE/D) to 65,000-71,000 BOE/D without adjusting its capex budget. Fueling the upward revision is the fact that Parsley Energy is getting more oil than expected out of new wells due to adjustments the industry is making to its drilling process to improve well productivity.
Given that oil inventories remain elevated, the market doesn't need this oil at the moment, which is why crude continues to slump and is reaching the point where shale drillers will have no choice but to cut back on drilling new wells. That potential drilling slowdown would likely have an impact on NOW's business in the second half of the year, just as its revenue is starting to recover from the market downturn of the past few years.
The industry needs to start slowing the flow of oil. Image source: Getty Images.
Those fears prompted analysts at Seaport Global to downgrade 51 oil stocks on Wednesday, including NOW. Seaport cut its rating on NOW from buy to neutral, and slashed the price target from $22 to $17, reflecting its new view on oil prices. Overall, Seaport Global sees $40 as the new long-term oil price, down from $50 a barrel due to "relentless" U.S. supply growth. Because of that production, Seaport believes that the oil market will remain "significantly oversupplied" in 2018, which would cause crude to crash into the mid-$30s in the first half of next year. That's a price point where few shale drillers can make money, which suggests another dose of tough times could lie ahead for the industry -- and for NOW.
Now what
The oil industry started 2017 on an optimistic note thanks to OPEC's decision to reduce its output and drain the market's supplies. Unfortunately, oil drillers let that optimism get the best of them as they opened their wallets and spent wildly on drilling new wells. Those wells unleashed a gusher of new production, which is overwhelming OPEC's output-reduction efforts. Now, the entire industry is paying the price, as those supplies are putting downward pressure on crude. The only solution is for drillers to cut back spending, which is increasing the likelihood that less revenue will flow to NOW later this year.
