What happened
Shares of a handful of small independent oil and gas producers, as well as a number of smaller oilfield service and equipment providers fell more than 10% on May 25. Profire Energy, Inc. (PFIE -3.33%), which manufactures burner management systems for oil and gas companies, fell 14.5%, while offshore energy industry transportation specialist Bristow Group Inc (BRS) fell 12.6%. Onshore drilling contractor Pioneer Energy Services Corp (PES) and offshore oil and gas producer W&T Offshore, Inc. both fell 11.4%, while independent oil and gas producers California Resources Corp (CRC) and Ultra Petroleum Corp (UPL) fell 10.5% and 10%, respectively.
The big downward catalyst was the same thing that sent oil prices down sharply on the day: word that Russia and OPEC -- primarily Saudi Arabia -- are on track to ramp up oil production in the second half of the year. It's expected that the OPEC/Russia alliance, which controls about 40% of global oil production, will add somewhere between 700,000 and 1.2 million barrels of oil per day in production in coming months.
Image source: Getty Images.
This news sent shocks through oil markets around the world. Brent crude futures -- a major global benchmark -- fell 3.3%, to $76.16, while West Texas Intermediate -- the main U.S. oil index -- fell 4.5%, to $67.50. Both hit multiyear highs only days before, with Brent closing at $79.80 on May 23 and briefly breaking $80 during intraday trading, while peaking at $72.24 on May 21.
So what
For producers like W&T, California Resources, and Ultra Petroleum, the drop in the price of oil futures will have a relatively clear result: lower prices will have a direct impact on their bottom lines. In addition, the market is getting ready for the next shoe to drop in the form of an official announcement for an increase in production from OPEC and Russia when they meet next month.
As for Profire Energy, Bristow Group, and Pioneer Energy Services, which all make a living by selling goods or services that producers use in the oilfield, it's a little more nuanced. All three are indirectly affected by oil prices since their services are generally required no matter the price of oil. However, it gets a little more complicated, since oilfield activity is affected by oil prices, with producers generally taking more actions to cut expenses when prices are falling. That can include reducing activities that these companies support, as well as pushing for lower prices.
As is often the case with oil-related stocks, today's big sell-off is almost entirely a product of fear based on expectations of what oil prices will do in the future. That shouldn't be unexpected, especially considering that oil prices have climbed steadily higher for more than two years. Since late January 2016, oil prices have increased almost 200%, driving almost all of the above stocks even higher:
UPL Market Cap data by YCharts.
And today's big oil price scare is frightening some investors -- some of whom may have already seen 300% or better gains in the past two years -- out of these stocks.
Now what
Frankly, it's hard to say what investors should expect going forward. It's reasonable to say that oil prices have gotten a little ahead of the real supply/demand environment and a "correction" was due to happen. But at the same time, investments in the oil patch were only increased about 6% this year and still are well below levels from a few years ago. This has resulted in substantially less new oil being discovered than has been produced and used over the past two years.
Furthermore, years of record-low spending on oilfield maintenance is on track to cause a significant decline in output from existing reserves, and it will take substantial investments to bring output back up in those oilfields.
Yes, OPEC and Russia are on track to ramp up production later this year, and that could have some short-term effect on oil prices. But that won't address the reality that years of underspending on maintenance and exploration is likely to have a bigger long-term role on supply, and that could send oil prices higher over the longer term.
