What happened

Shares of U.S. exploration and production company Oasis Petroleum (NYSE:OAS) fell as much as 36% in early trading on June 10. QEP Resources (NYSE:QEP) dropped 33% and SM Energy (NYSE:SM) fell a relatively modest 16% or so. It's the second consecutive day that these companies have faced heavy selling on Wall Street.

The last two days, however, have marked a huge reversal in attitude toward these stocks. In fact, over the past five days, the shares of SM Energy are still up 29%. QEP remains higher by nearly 95%. And Oasis' gain is an incredible 155% or so. What's even more telling is that at one point during that five-day span Oasis was up more than 240%, with QEP peaking around 150%, and SM Energy reaching a high of a 60% or so.

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Image source: Getty Images.

So what

The key thing for long-term investors to keep in mind here is that the performance numbers being discussed are for just five trading days. The energy sector is volatile and prone to swift ups and downs, but the risk-on/risk off-shift here is quite dramatic. It's as if investors forgot about the underlying headwinds that U.S. exploration and production companies are facing because of some good news, and then suddenly remembered that nothing, as of yet, has changed all that much in the industry.

For example, OPEC and Russia agreeing to extend production cuts is indeed good news that could help alleviate the supply/demand imbalance that exists today. However, OPEC members have a pretty lousy track record of living up to their promises and it will still take some time for the cuts to work off all of the excess oil that's in the system. In addition, some of the upbeat mood from investors is related to the fact that oil prices have risen to the point where U.S. E&P names are opening up wells that they had shut down because of low prices. That will clearly help companies generate the cash flow they need to keep operating, but it doesn't mean the troubles are over in the industry. 

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For example, Bloomberg, citing people familiar with the situation, reported after the close on June 8 that Chesapeake Energy (OTC:CHKA.Q) was on the verge of declaring bankruptcy. Even rising oil prices can't help a company with weak fundamentals. E&P names like those here started to fall the very next day (along with Chesapeake), as if this was some shocking development. It wasn't. Motley Fool's Matthew DiLallo wrote about the company's hiring of restructuring advisors back in early May.    

It's worth noting that financial debt-to-equity, which looks at stock market capitalization, was troublingly high for Oasis Petroleum (about 10 times), SM Energy (19), and QEP Resources (23) at the end of the first quarter. Looking at just balance sheet data, SM Energy's debt-to-equity ratio is a high 1.1 times, with QEP coming in at 0.6 times, which is a bit elevated when you consider the inherent volatility in the energy space. Oasis' debt-to-equity ratio is negative because write-offs have left it with negative shareholder equity, which is obviously not a positive thing.   

And even the good news could actually end up being a headwind here. The fact that U.S. E&P names are starting to reopen shuttered wells could easily end up offsetting the cuts OPEC is making. Meanwhile, if energy prices move high enough, U.S. drilling activity, which is very low today, could quickly pick up again and cap oil's price gains. If that happens, it's not unreasonable to expect oil to fall into another deep downtrend. In other words, based on the price performance here, it looks disturbingly like investors are trying to time an industry recovery without really looking closely enough at the individual companies involved or the big-picture implications of positive, and negative, news on the industry.

Now what

If you are looking to invest in the energy sector, you should probably do so in a conservative manner. That might mean buying a diversified basket of E&P names via an ETF or, perhaps better, switching from small U.S. focused E&P names to financially strong industry giants with diversified business models, like Chevron, which, as part of a broader portfolio of assets, has a sizable U.S. onshore operation.