What happened

Shares of U.S. exploration and production company Callon Petroleum (CPE -4.17%) fell nearly 11% in the first half hour of trading on Sept. 8. Following close behind was SM Energy (SM 4.66%), which dropped just over 10%. Centennial Resource Development (PR 2.04%) got in on the act as well, with its shares declining as much as 8.5% as trading got underway.

This is really just another day in what has amounted to a really awful year for this trio. At this point, the stocks are all down more than 80% in 2020. While that's up from the worst of the downturn between March and May, it's still a pretty dismal showing and a painful hit for investors. The coronavirus-related economic shutdowns across the world were a big piece of the puzzle, as they led to an extreme decline in demand in the energy sector. In fact, oil prices fell to zero at one point in the year. But this isn't the only issue Callon, SM Energy, and Centennial are facing.

A worker writes in a notebook in front of an oil well.

Image source: Getty Images.

So what

Weak demand for oil and natural gas led to falling prices. That oversupply situation, meanwhile, led to an increase in the amount of these energy sources held in storage. The extra oil and gas needs to be worked off before energy prices can be expected to rise materially. While the world is reopening again, and demand is starting to increase, the big question is whether or not it will increase quickly enough to sop up the extra supply still sloshing around in the sector. Nothing moves in a straight line, so updates one way or the other can move energy prices, often dramatically. Oil prices were heading down sharply this morning. Natural gas was lower, too, but not to the same degree. 

Although oil prices are the big picture story impacting Callon, SM Energy, and Centennial today, there's another important piece of the puzzle. All three are heavily leveraged names in the U.S. onshore space. The U.S. onshore niche of the energy market has been particularly hard hit, with many debt-laden names already falling into bankruptcy. Some industry watchers suggest that more bankruptcies are yet to come before the energy downturn is over.

But it pays to put some numbers behind that view. Centennial Resource Development is probably the best positioned, with a financial debt-to-equity ratio of around 4.5 times. To put that in perspective, however, energy industry giant Chevron has a ratio of just 0.20 times. Callon and SM Energy are even more leveraged, with financial debt-to-equity ratios of roughly 5.8 times and 7.3 times, respectively. None of the trio is covering its trailing 12-month interest expenses at the moment.   

CDEV Financial Debt to Equity (Quarterly) Chart

CDEV Financial Debt to Equity (Quarterly) data by YCharts.

With debt-heavy balance sheets and weak oil prices, it's not surprising that investors get a little extra worried when energy prices head lower. Even refinancing debt, while the right move for the near term, can have negative long-term implications. For example, in May, Centennial effected two debt exchanges, resulting in interest costs rising 5.375% and 6.875% on the two issues to 8% on the single new issue. The company bought time, but at a material cost. SM Energy did something similar, and Callon tried to get a debt exchange done recently but ended up unable to do so. The companies are working very hard to make it through to the other side of this downturn, but it is difficult sledding right now and volatile energy prices don't help at all. Investors are justified in being concerned here.  

Now what

Energy prices are notoriously volatile and, at this point, the stocks of SM Energy, Callon Petroleum, and Centennial Resource Development are all highly sensitive to the ups and downs. These are not appropriate investments for conservative investors. In fact, the only thing that you can probably count on from here is continued volatility.