What happened
Shares of offshore energy services provider Transocean (RIG -2.69%) rose a dramatic 13.5% in early trading on Nov. 18. Although those gains didn't hold for long, the shares of this energy industry player were still up around 9% at 11 a.m. EST. There's an easy answer for the price action, and then there's a more complex view of things.
So what
The simple logic here is that oil prices rose in early trading and then started to cool off. So it shouldn't be a shock that this energy services company's stock followed along for the ride. But that's just a surface view, since Transocean doesn't actually drill for oil. That's what its customers do -- it just helps them get the job done with a focus on the offshore sector.
Image source: Getty Images.
However, capital spending in the highly cyclical energy sector is tied to oil and natural gas prices. Prices are low today thanks to the economic shutdown used to slow the spread of the coronavirus and, thus, exploration and production companies have been pulling back on spending. That's reducing demand for Transocean's services. The company's revenue in the third quarter fell year over year and sequentially from the second quarter, so there are clear headwinds today.
OPEC has been reducing production to help get supply and demand back into better balance. The group's current round of cuts is set to end shortly, but industry watchers are suggesting that OPEC will extend its cuts again. Thus, oil prices rose. And, in turn, investor sentiment around Transocean's future prospects brightened. That said, there's still a huge amount of oil sitting in storage that has to be worked off. And COVID-19 cases are on the rise again, suggesting that demand will remain weak. So even if OPEC does maintain its supportive stance, there are material headwinds for the industry to deal with. It's way too soon to call an all-clear for energy drillers or the companies like Transocean that provide vital services to them.
Now what
The energy sector is a volatile place right now. Most investors would probably be better off sticking to larger, more diversified, and financially strong industry participants. That's not to suggest that Transocean is a bad company, but the risk/reward profile of the industry today does suggests that playing it safe is probably the best option. In other words, an energy giant like Chevron should probably be higher up on your wishlist than an energy services name like Transocean right now.
