What happened

Crude oil prices took a beating on May 23, with Brent futures closing down 4.3% and West Texas Intermediate futures falling 5.2%. For context, a single-day drop in oil prices of more than 2% is considered very big; today's sell-off was simply massive.

Earlier today, my colleague Tyler Crowe highlighted five other oil stocks sent lower by today's crude sell-off; by close, the list had expanded broadly across the oil sector. At the end of trading, these eight oil stocks had closed between 5.5% and 23% down:

Company Subsector Price Change
Baytex Energy (BTE -1.18%) Oil and gas producer (7.6%)
California Resources Corp. (CRC) Oil and gas producer (16.2%)
Chesapeake Energy (CHKA.Q) Oil and gas producer (5.9%)
Denbury Resources (DNR) Oil and gas producer (9.9%)
Ensco Rowan (VAL) Offshore drilling contractor (11.6%)
Extraction Oil & Gas (XOG) Oil and gas producer (8.9%)
Laredo Petroleum (LPI -1.94%) Oil and gas producer (8.4%)
Seadrill (SDRL) Offshore drilling contractor (22.9%)

So what

What's driving the big drop in oil prices, and therefore oil stocks? The biggest news is a report from the U.S. Energy Information Administration (EIA) highlighting two things:

  1. U.S. oil production recently reached 12.2 million barrels per day, and remains on track to reach the highest levels in history in 2019.
  2. The EIA said U.S. crude oil inventories are at two-year highs.

And when you combine record levels of production with very high inventories of crude oil, oil speculators tend to react as they did today, sending oil prices -- and oil stock prices -- crashing.

A man in a suit watches a red stock-chart arrow crash through the floor.

Image source: Getty Images.

Now what

Oil prices are really important to how oil producers make a living -- selling oil -- so lower prices aren't good. That's particularly true for producers like California Resources, which primarily owns legacy oil and gas resources which can be more expensive to produce.

So there are real potential implications if the glut of oil inventories and record production result in a protracted oversupply. The end result would be a continued decline in oil prices; if that were to happen, it would indeed be problematic for many independent producers.

However, West Texas and Brent futures are still near $60 and $70 per barrel respectively, which are profitable prices for the vast majority of oil producers today.

What about the offshore drillers?

As Tyler pointed out in his earlier piece, oil prices are a secondary concern for offshore drillers; their business results are more a product of demand for offshore drilling services and the available supply of vessels. Over the past few years, hundreds of older vessels have been taken out of service, and dozens of competitors have either gone out of business or merged with others. This consolidation has helped improve the quality of the sector significantly.

However, in Seadrill's case today, that company couldn't have picked a worse day to announce disappointing earnings. The company released its first-quarter results before market open today; it reported a $296 million net loss and a $71 million operating loss, and announced it may consider selling off some of its fleet to accelerate the payoff of high-interest debt. So investors are "rewarding" the company with a double-dip beating, on both the bad news and fears that falling oil prices will hurt offshore drillers, too.

The big takeaway

Don't buy or sell any oil stock solely based on a big change in oil prices. Take the time to understand the implications of higher or lower oil prices -- both short- and long-term -- for that particular company, and factor them into your long-term thesis. That will give you the power to know when sell-offs like today represent opportunities to buy high-quality companies, and when they're just noise you can ignore.