What happened
Shares of drilling services giant Schlumberger NV (SLB -1.17%) rallied as much as 11.5% in early trading on May 18. Energy sector peer Patterson-UTI Energy (PTEN -0.97%) jumped nearly 14%. And Halliburton Company (HAL -1.04%) topped out at just under 15%. The companies gave back a portion of those gains as the day wore on, but by around 2:30 p.m. EDT, they were still up roughly 10%, 11%, and 13.5%, respectively. The reason for the big uptick isn't hard to figure out. Oil prices were in rally mode, with investors spreading the love throughout the entire sector -- including energy services names.
So what
Oil prices have faced a series of material headwinds of late. Coming into the year, the supply/demand equation was tilted a little too heavily toward oversupply because of the U.S. onshore drilling sector's more than decade-long rise on the global stage. The extra oil basically upended the normal functioning of energy markets the world over.
Image source: Getty Images.
OPEC had been working to deal with that issue by cutting supply. Only the U.S. isn't a part of OPEC and the individual drillers that make up the U.S. market simply kept increasing output even as OPEC cut. So the worldwide level of production remained high. Eventually, OPEC and partner Russia had a falling out over the effort to curtail oil production and got into a price war, effectively flooding the market with oil. Although that little spat only lasted a short period of time, with the two sides agreeing (with the U.S. in the mix) to again focus on cutting production, the damage was done.
That's because at roughly the same time OPEC and Russia opened the oil taps, the global effort to contain COVID-19 was leading economies around the world to shut down. With people trapped in their homes and non-essential businesses closed, demand for oil and its various byproducts fell sharply. In other words, at the very same time that supply was rising, demand was plummeting. There was so much oil floating around that it was quickly filling up the world's available storage capacity. Oil prices declined to record lows.
With oil prices so low, exploration and production companies started to cut back hard on their capital spending plans. Some heavily leveraged drillers have even been forced to seek out the protection of bankruptcy courts. Put it all together and energy services companies like Patterson-UTI, Halliburton, and Schlumberger were seeing business dry up.
The pain isn't likely over, either, unless the excess oil in storage gets whittled down to more normal levels. That, however, is what some investors clearly thought might happen today, as they pushed oil prices sharply higher. At least a part of that enthusiasm was related to Moderna's announcement before the market open on May 18 that it had experienced early success with a COVID-19 vaccine. That comes on top of some generally encouraging news recently about the oversupply situation starting to ease.
But the big story today is that, if a vaccine were to be available, economic activity around the world could more quickly return to pre-coronavirus levels. In that scenario, demand for oil would recover more quickly and the supply/demand imbalance would right itself at a rapid pace. Assuming that led to higher oil prices, oil companies would start spending again, which would benefit services companies like Patterson-UTI, Halliburton, and Schlumberger.
Patterson-UTI, which has significant exposure to onshore U.S. drilling, might benefit first from an upturn. U.S. non-conventional drilling is more easily brought online than more traditional drilling, like offshore wells. That said, Patterson-UTI could use some good news, as it posted a loss in 2019 and in the first quarter of 2020, with revenue plunging in both periods.
Halliburton and Schlumberger are larger players in the energy services space, with global operations. They've both been shifting gears in recent years, pulling back on U.S. drilling and placing more emphasis on offshore drilling and drilling in non-U.S. locations. Part of the goal has been to prioritize business that would provide more consistent revenue because of the nature of the customers and drilling programs involved. Despite that shift, the low oil price environment has still led both to bleed red ink.
In other words, rising oil prices would be a blessing for three of these companies.
Now what
One day does not make a trend in the often volatile commodity markets, so investors shouldn't read too much into today's oil advance or the big gains for these energy services providers. That's doubly true given that a big part of the story today is excitement over a vaccine that is still only in the early stages of being tested. There's a lot more work that has to be done in the oil market (balancing supply and demand) and with the vaccine before oil prices can mount the type of sustained rally that will lead to increased spending on exploration -- which is really what Patterson-UTI, Halliburton, and Schlumberger need before their businesses can recover.
