What happened
Shares of Baker Hughes (BKR -1.00%) rose an impressive 33% in April, according to data provided by S&P Global Market Intelligence. Halliburton (HAL 0.34%) jumped an even more incredible 53% during the month. And the value of Core Laboratories' (CLB) stock increased by an astounding 90%. But even after these large advances, Baker Hughes is still down 46% for the year. Halliburton is off by 60%. And Core Labs is lower by 53%. There's a lot going on in the energy sector, and the turmoil is not nearly close to being over, especially for energy services companies.
So what
The big story in the oil and natural gas space is that supply has swamped demand. A combination of factors created this situation. For example, the excess supply has its roots in the long rise of U.S. onshore oil output. That output upended the normal functioning of the global energy markets, with OPEC trying to play referee to accommodate the new supply without a major price slump.
Image source: Getty Images.
The oil group cut production to offset the new output. But the more it cut, the more U.S. onshore drillers produced. Eventually OPEC and partner Russia disagreed on this approach and got into a price war. The supply spigot was opened up and oil prices plunged. That happened in early March, a disastrous month for any company related to oil.
As OPEC and Russia were getting into this tiff, COVID-19 was forcing countries around the world to effectively shutter their economies. The goal was to slow the spread of the coronavirus by forcing people to stay at home. That effort appears to have worked, but it led to a dramatic decline in demand for oil at a time when supply was high (and increasing). Oil prices have fallen to frighteningly low levels. OPEC, Russia, and the United States have since come to terms on production cuts, but the damage has been done.
Effectively, all of the excess oil has ended up in storage. With storage around the world largely full and demand still relatively weak, oil and gas prices are likely to remain depressed for much longer. This is terrible news for energy services companies, even industry leaders like Halliburton, Baker Hughes, and Core Labs.
The problem: The oversupply needs to be resolved before oil can start a sustained rebound. As economies open up again, demand will slowly come back. But that alone won't be enough. Low energy prices are leading to a massive pullback on capital spending by exploration and production companies. Some smaller players are even going bankrupt. It's actually a healthy clearing process for the energy industry as a whole, even if it's a painful one. But it means demand for energy services is not only weak, but likely to get even weaker in the near term. Energy industry Goliaths ExxonMobil and Chevron, for example, have each announced plans to trim capital spending by 30%. They aren't alone.
The spending cuts aren't impacting just onshore U.S. drilling. The effects are reaching offshore drilling, traditional onshore projects, natural gas, and fracking. Even spending in the midstream (pipeline) sector is getting upended. With a broad spending pullback, the entire spectrum of energy services are going to continue to feel the pain. Energy services companies are making changes, cutting costs and laying off staff, for example, but that effort will take time, and it doesn't really solve the demand decline -- it just makes it easier to muddle through the tough times.
Now what
When oil companies pull back, energy services firms tend to get hit extra hard. That's exactly what's going on today. Although market sentiment improved overall in April, after a terrible March, investors shouldn't read too much into the stock price gains at Halliburton, Baker Hughes, and Core Labs. The energy services space is in for more pain before business starts to pick up again. It all goes back to the supply-demand imbalance in the energy markets. Until that's cleaned up, this trio will be facing material headwinds.
