What happened

Shares of energy company Centennial Resource Development (NASDAQ:CDEV) fell a quick 15% as trading began on Wednesday, May 6. By about 11 a.m. EDT, the stock was hovering around a 10% decline.

The company reported earnings after the close on Monday, May 4, and the stock proceeded to drop sharply on May 5. As trading began on May 6, the shares remained under pressure. The problem for Centennial is that things have to get worse before they can get better.

So what

Centennial's first-quarter earnings were pretty much a disaster, with the top line falling 10% year over year and the bottom line dropping from a loss of $0.03 per share in the first quarter of 2019 to a loss of $1.99 per share in 2020. The company took just over $600 million worth of impairment charges in the quarter, which obviously had a negative impact on earnings. But the big picture here is that oil and natural gas prices are painfully low today, and that's having a massive impact on Centennial's business. 

A man standing in front of an oil rig with tablet in his hand

Image source: Getty Images.

This is the reason why the company received mention in a Wall Street Journal article on May 6 highlighting the difficulties that energy companies like Centennial are facing. That probably didn't help the stock much. But in truth, the moves the company is making will be a material headwind.

For example, along with earnings, Centennial announced that it was trimming its operating rig count from five to zero, as all near-term drilling plans have basically been put on hold. Further, it expects to curtail output by as much as 40% starting in May.

With oil prices so low lately, these moves make strategic sense -- it's better for the company to preserve its energy assets for a point in time when prices are higher. But pulling back so hard will have a negative impact on Centennial's future financial performance. How long and how deep the hit will be is hard to tell, since a return to more normal drilling and production levels will depend on energy prices. 

Now what

There's a severe supply/demand imbalance in the energy sector today, resulting in deeply depressed commodity prices. Centennial is trying to adjust as best it can, but there's a lot of near-term pain involved.

Since energy prices aren't likely to mount a sustained rally until the supply/demand imbalance is resolved, there's no telling how long Centennial will have to limit its operations. At this point, high levels of volatility are likely to be the norm for this stock.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.