What happened

Shares of Carrizo Oil & Gas Inc. (NASDAQ:CRZO) are getting pounded on Tuesday and were down more than 17% at 10:00 a.m. EST. Fueling the sell-off was the driller's outlook for 2018.

So what

Carrizo Oil & Gas posted its fourth-quarter report after the market closed yesterday. The results weren't bad since it earned an adjusted $0.58 per share, which beat the consensus estimate by $0.01 per share. Furthermore, oil and gas production jumped 39% and was above the high end of the company's guidance range.

Three oil-field workers on a drilling rig against a bright orange sunset.

Image source: Getty Images.

Instead, what's driving the sell-off was Carrizo Oil & Gas' outlook for 2018, when it plans to spend $750 million to $800 million on capex, which "incorporates an assumed double-digit increase in oilfield service costs." As a result of that inflation, its production will only rise 10% this year. While the company said that it was working on offsetting some of this cost pressure with further efficiency gains, it hasn't factored those potential savings into its budget.

It's worth noting that Carrizo isn't the only driller battling cost inflation. Parsley Energy (NYSE:PE), for example, noted last month that its capital spending came in at $1.2 billion last year, which was above its $1 billion to $1.15 billion guidance range. Parsley Energy also said that spending in 2018 would come at the high end of its $1.35 billion to $1.55 billion budget range due to the "likelihood of service and equipment cost inflation." That said, larger drillers like Pioneer Natural Resources (NYSE:PXD) aren't getting hit as hard due to their scale and vertically integrated operations. In the case of Pioneer Natural Resources, the company is only assuming 5% cost inflation in its budget this year instead of the 10% to 15% anticipated by the industry because it was able to lock in low-cost sand supplies, for example. Pioneer, however, fully expects to offset the impact of inflation through additional efficiency gains.

Now what

With oil prices improving, oil-field service companies are beginning to charge drillers more for services and equipment after giving them a break during the market downturn. That cost inflation is hitting smaller drillers like Carrizo and Parsley harder because they don't have the scale of companies like Pioneer to push back in other ways. Because of that, investors might want to consider investing in larger, low-cost drillers like Pioneer since they're becoming cash flow machines while smaller rivals are struggling to keep up.

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