Shares of U.S.-focused energy and exploration company Penn Virginia Corporation (PVAC -3.70%) fell as much as 16% on June 9. Fellow onshore drillers Continental Resources (CLR -0.68%) and Marathon Oil Corporation (MRO -1.11%) fell roughly 13.5% and 11%, respectively, at their lowest points. By roughly 3 p.m. EDT, the trio had clawed back some of those losses, but still remained materially lower on the day, with Continental and Marathon down around 10% and Penn Virginia off by about 15%.
That comes after a series of big days, notably on June 8. Indeed, over the past five days, Penn Virginia was up 37%, Continental Resources 33%, and Marathon Oil 30%. Clearly, investors' moods went from positive to negative overnight. That's largely related to big-picture issues facing oil stocks today.
Oil prices fell hard earlier in 2020, as a combination of unfortunate factors pushed prices temporarily below zero. In theory, that means that oil drillers were paying customers to take the oil they had drilled. That was a pretty historic event, and it freaked the market out. Part of the reason this came to pass, however, was the long-running growth trend in onshore U.S. production, something in which Penn Virginia, Continental, and Marathon all played a part. That sets an important stage, because increasing supply of U.S. oil upended the global supply/demand balance.
OPEC attempted to offset the increase in supply by cutting its output. U.S. drillers, all acting independently with no central body controlling them, simply stepped into the void and offset any slack that OPEC created. That led to a rift between OPEC and partner Russia that resulted in even more supply hitting the market, further exacerbating the existing problems.
At roughly the same time, COVID-19 started to spread around the globe. Economies were effectively shut down to slow the spread of the coronavirus, leading to drastically falling demand for oil and natural gas. So there was more supply right when demand was plummeting, and prices fell sharply as oil started to pile up in storage tanks around the world.
However, things have started to get better. For starters, OPEC and Russia mended their relationship and have agreed to cuts. Over the just-ended weekend, they extended the curbs again. That will help reduce supply. U.S. drillers started to pull back on drilling efforts and even began to shut active wells, further curtailing the amount of oil floating around. And countries around the world have been reopening their economies, which should help increase demand. Oil prices have risen off their historic lows, with West Texas Intermediate oil climbing into the $40 per barrel range. Investors lifted exploration and production names along with the price of oil and the flow of relatively positive news.
On June 7, meanwhile, a Wall Street Journal article noted that U.S. oil companies were starting to reopen closed-in wells. Although oil wasn't high enough to justify new drilling, existing wells could still turn a profit in some cases and cash-starved drillers were eager to take advantage of the situation. That's good news in an industry that has seen a number of companies fall into bankruptcy. When the trading day opened on June 8 it seemed like investors believed the trend had turned and even heavily indebted U.S. drillers would be saved.
That didn't turn out to be the case, with Bloomberg reporting after the close on June 8 that Chesapeake Energy was on the verge of declaring bankruptcy. Clearly, the tide hadn't turned enough to lift all boats in the energy patch, particularly those with extra-heavy debt loads, a list that actually includes Chesapeake, Penn Virginia, Continental, and Marathon. These companies all have financial debt-to-equity ratios that are at least seven times higher than that of conservative integrated energy giant Chevron. Investors basically started to rethink their enthusiasm for the entire group, and for good reason.
Reopening wells will bring additional supply to market and, once again, offset the cuts OPEC was making. OPEC members, meanwhile, have a bad habit of ignoring the limits they agree to. And higher oil prices will help debt-heavy drillers deal with their leverage issues, but they aren't enough to completely solve the problem. A lot more good news, on a sustained basis, will be needed to do that. In the end, after a particularly big run, investors decided that, perhaps, U.S. exploration and production names had run a little too far a little too fast.
Oil drillers continue to face very big issues. That includes industry-wide factors like a still out-of-balance supply/demand equation, the need to work down excess oil sitting in storage, and the always contentious nature of OPEC's deals. On top of that, there are company-specific problems that need to be addressed, notably debt-heavy balance sheets. In short, investors have gone from risk-on to risk-off and for good reason. But this roller coaster ride is far from over and investors should expect plenty more ups and downs from here in this highly cyclical industry. Most investors should probably err on the side of caution and stick with financially strong and well-diversified oil giants, like Chevron.