What happened
Shares of oilfield services companies Core Laboratories (CLB 6.89%) and NexTier Oilfield Services (NEX 9.81%), surged Monday, as did small-cap explorer and producer Gran Tierra Energy (GTE 9.77%). The stocks ended the session up by 6.9%, 9.9%, and 9.2%, respectively.
It wasn’t hard to understand why. On Sunday, members of the Organization of the Petroleum Exporting Countries (OPEC) surprised global markets with a significant cut to crude oil production. As a result, oil prices were on the rise Monday, lifting these three small-cap oil-related stocks along with them. But were these big moves justified, especially for the services companies?
So what
Over the weekend, eight members of OPEC+ decided to cut production by a total of 1.16 million barrels per day in response to perceived macroeconomic weakness that had driven prices down as low as $65 per barrel in recent weeks. The move follows last October’s 2 million barrel-per-day cut, which was also intended to boost oil prices. Leading the charge is Saudi Arabia, which will cut by 500,000 barrels per day beginning in May, with participation from the other major OPEC+ countries. In addition, Russia said it would extend the 500,000 barrel-per-day production cut it announced back in February through 2023.
In response, oil prices rose Monday by about 6%, exceeding $80 per barrel for the first time since early March, before the U.S. regional bank crisis dented demand due to fears that crisis would lead to a slowdown in global growth.
Higher oil prices obviously benefit Gran Tierra, which is a small-cap producer with conventional oil drilling properties in Ecuador and Colombia. Gran Tierra’s small size gives it potentially a lot of upside if oil prices rise, although the company also has higher risks due to its size. In its recent guidance, Gran Tierra said its free cash flow in 2023 would only be $25 million at $75 per barrel oil, but would rise to $65 million at $85 oil, and $105 million at $95 oil. Gran Tierra’s market cap is only $293 million, so small swings in the price of oil can lead to big differences in its financial results.
Oil’s move higher also positively affected the share prices of oilfield services companies, although it’s a bit of an open question as to how much higher crude will improve their results.
It’s probably more of a bullish catalyst for NexTier than Core Labs, as NexTier is mostly focused on U.S. shale operations. Obviously, OPEC+ members are cutting back production — by contrast, U.S. onshore producers will likely go ahead with their growth spending in 2023. So, NexTier should continue to benefit, as a higher oil price could lead to either unchanged or even more robust U.S. production.
However, Core Labs, while having some production enhancement revenues in the U.S., is mostly exposed to international and offshore reservoir description services. Therefore, while a higher oil price is a good thing for Core, all things being equal, the potential for a deceleration in international drilling due to this production cut may not be the boon shareholders apparently think it is now.
As the chart below reflects, Core Labs hasn’t participated in the oil industry boom that has occurred since the depths of the pandemic to the extent that Gran Tierra and NexTier have. Surprisingly, NexTier has benefited even more than Gran Tierra, even though producers have generally done better than the service providers since then.
CLB data by YCharts.
Now what
It’s probably a smart idea for investors to have some exposure to oil and natural gas stocks in their portfolios. As we saw last year, energy supply shocks can greatly disrupt the global economy and lead to inflation that tends to hurt stocks in other sectors. Then there are days like Monday, when a surprise announcement from OPEC+ sent oil stocks higher, but pushed tech stocks and other sectors generally lower.
With the Russia-Ukraine war still raging, there is still a lot of global supply that is in a dubious position. Meanwhile, fears over a global economic slowdown and potential recession have caused oil stocks to sell off this year, and many still trade at low valuations. While the sector can be volatile, oil and natural gas related stocks can act as hedges against global supply shocks, and many of these companies pay dividends and repurchase shares often. No wonder Warren Buffett has continued to purchase his favorite stocks in the sector this year.