What happened
Oil prices are snapping back on Thursday, one day after nosediving to their lowest level since 2002. At noon EDT, WTI, the U.S. oil benchmark, had rallied more than 18% to above $24 a barrel.
That rebound in the oil market fueled a rally in most energy stocks. One group that bounced back sharply was oil-field service stocks. Leading the way were Core Labs (CLB +0.00%), Oceaneering International (OII +3.20%), and National Oilwell Varco (NOV +0.48%), which all jumped double digits by the mid-morning.
Image source: Getty Images.
So what
There wasn't any fundamental news driving the rebound in the price of oil. Demand continues to fall due to the COVID-19 outbreak, while supplies remain strong because Saudi Arabia and Russia are pumping at full speed following the collapse of their production support agreement. U.S. oil producers, however, have been slashing their drilling budgets, which will have some impact on their production this year.
Continental Resources (CLR +0.00%), for example, announced today that it would reduce its budget by 55% this year in response to the collapse in oil prices. As a result, Continental Resources expects its production to decline by 5% compared to last year's level.
On the one hand, these budget cuts will impact their sales and earnings of oil-field services and equipment companies like Core Labs, Oceaneering International, and National Oilwell Varco. The sector had already been under significant pressure in recent years because the oil market never fully recovered from the 2014 downturn. Because of that, many services and equipment companies still have weak financial profiles, which is a concern given the amount of debt they have maturing in the coming years. Credit rating agency Moody's recently warned of a "severe and extensive credit shock" across the oil market, with oil-field services companies likely to "face the brunt of the sector's weakness, and therefore the greatest refinancing risk."
Core Labs has already announced steps to get in front of this issue. The company not only cut its capital spending level but also reduced its dividend again. These moves will save it about $73 million per year, which it plans to use to accelerate debt reduction. Oceaneering and National Oilwell Varco will also likely need to reduce spending to ensure that they remain on a solid financial footing.
On a more positive note, the deep capex cuts by producers will eventually reduce supply and should help stabilize oil prices. On top of that, demand could rebound sharply once governments contain the COVID-19 outbreak. Meanwhile, the significant decline in oil prices could eventually bring Russia and Saudi Arabia back to the bargaining table. These moves could all help support higher oil prices in the future, which could drive a rebound in oil field service activities in the coming months.
Now what
Oil prices will likely continue making wild swings until there's more certainty around when the global economy can get back to some sense of normal. The longer they stay lower, however, the worse it will be for oil services companies, especially those with very weak financial profiles. If things don't improve soon, several companies might end up in bankruptcy.
That's less of a risk for financially stronger companies like Core Labs, National Oilwell Varco, and Oceaneering International. However, it doesn't mean these stocks won't quickly give back today's gains on another sell-off in the oil market, which is why investors might want to avoid buying oil stocks until industry conditions stabilize.
