What happened

Shares of energy services provider Nabors Industries (NYSE:NBR) were down by more than 20% on June 24. Peers Borr Drilling (NYSE:BORR) and Patterson-UTI (NASDAQ:PTEN) were both off by around 12%, better than Nabors, but still a huge amount of red ink for a single day on Wall Street. A material oil price decline was the obvious reason for the drops here. That said, there's some important backstory that investors need to understand before even considering dipping a toe into this out of favor sub-sector.

So what

COVID-19 has upended the energy industry. There were already oversupply issues when the coronavirus began spreading across the world in early 2020. So when countries started to effectively shut their economies down to slow the spread, oil prices took a massive hit as demand crashed. It was so bad that oil actually traded below zero at one point. Although it was a temporary dip and there were some unique technical issues involved, for a brief moment in time drillers were essentially paying customers to take their oil. It's obviously not that simple, but the takeaway is that the energy industry was in a very bad place.

Oil rigs with the sun setting in the background

Image source: Getty Images.

Energy related names fell sharply. For companies that drill for oil, there's a pretty direct relationship that's easy to grasp: Low oil prices means weak revenues and earnings. For service providers like Nabors, Borr Drilling, and Patterson-UTI, however, the impact is a bit more complicated. These companies get paid to provide specific drilling services to the exploration and production companies. When oil prices are low, the E&Ps tend to pull back on drilling, which means less business for energy services firms. Unlike an E&P company, where rising oil prices can relatively quickly lead to improved financial results, energy services need to see an uptick in their customers' capital spending before business begins to improve. That can take a long time to materialize when times are really tough, like today.

With the global economy starting to come back "online," so to speak, oil prices had begun to pick up again. Investors got excited, believing that the worst had passed for the energy sector. But many of the areas that have begun to reopen their economies have witnessed an uptick in COVID-19 cases. Investors are increasingly concerned that the economic rebound will be slow and drawn out. That, in turn, will mean weak demand for oil. Oil prices fell today because of that, dragging energy services firms along with it. But the really big issue is that the longer oil prices remain under pressure, the longer it will be before E&Ps start to spend on drilling services. This news is, in some ways, extra bad for services firms like Nabors Industries, Patterson-UTI, and Borr Drilling, that need to see that uptick in spending before their businesses start to turn a profit again. It could actually get worse before it gets better because of all the excess oil sitting in storage that needs to be worked off. 

NBR Chart

NBR data by YCharts.

None of these companies is doing particularly well right now, as you might expect. For example, Borr Drilling has been forced to restructure its debt agreements and push out equipment deliveries, among other things. Nabors enacted a 1 for 50 reverse stock split (usually not a good sign) and adopted a poison pill to ward off unwanted acquisition advances (presumably an effort to dissuade larger companies). Patterson-UTI, meanwhile, was operating 123 rigs, on average, in the first quarter but had only 80 rigs working in May -- a huge 35% decline in just two months. These are painful examples of how bad things are today in the energy services space, and for these companies specifically.    

Now what

There's no easy answers when it comes to the broad impact that the coronavirus pandemic has had on the world. In the energy sector, it looks like the road to recovery will be slow and uneven, at best. That's bad for exploration and production and even worse for the energy services companies like Nabors Industries, Patterson-UTI, and Borr Drilling, that rely on them. This is not a sector for the faint of heart. And if you do dare to invest here, expect volatility to remain extreme.

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.