The shares of energy service provider Core Laboratories (NYSE:CLB) rose nearly 9% in the first two hours of the trading day on November 23. Even more impressive was the nearly 14% increase for Helix Energy Solutions (NYSE:HLX). However, the most impressive increase was seen at Transocean (NYSE:RIG), which posted a price rise of almost 20%. The major price movements here all relate to the same theme: improving oil prices.
Several relationships are involved here. First of all, Core Labs, Helix and Transocean provide important services to energy companies in the exploration and production of oil and gas. However, demand for their services is highly dependent on oil and gas prices. Higher energy prices tend to lead to more drilling, and lower prices usually lead exploration and production (E&P) companies to reduce their capital expenditures. In other words, rising and falling energy prices correlate with rising and falling demand for energy services companies.
The simple logic for the price movements of this trio is therefore that energy prices have risen and have led to an optimistic view of investors. In essence, Wall Street assumes that demand for Core Labs’ digital solutions and Helix and Transocean’s drilling services would increase from current levels. But there is a small catch here: all three companies have recently reported weak results. For example, Transocean’s adjusted loss in the third quarter of 2020 was $0.11 per share, after breaking even in the second quarter of the year. Helix’s earnings per share were $0.10 in the first nine months of the year, compared to $0.33 in the same period in 2019, and Core Labs generated $0.07 per share in the third quarter, compared to $0.53 per share a year ago.
The reason for the weakness is that the economic shutdowns used to slow the spread of the coronavirus have led to a massive imbalance between supply and demand in the energy sector and to persistently low prices. As supply dwarfs demand, companies have been forced to drastically reduce their investment plans. The attractive effect is that the energy service companies had to struggle with the headwind of the economy. Therefore, the rising energy prices are particularly positive at the moment.
In fact, there has been a positive development on the vaccine front in each of the last three weeks. The most recent vaccine is from AstraZeneca, which reported that its COVID-19 vaccine was up to 90% effective in the trials it conducted. With three vaccines already showing promising initial results, investors are increasingly confident that demand for oil and gas will return once the economy fully recovers. This should help to absorb the excess supply in the energy sector. But this is not the only dynamic in the market, as supply is also being restricted by the energy industry’s withdrawals. OPEC, for example, has cut back production to offset the imbalance between supply and demand on the supply side. As it is likely to take a while for the demand for vaccines to skyrocket, energy investors were also encouraged by the growing conviction that OPEC will continue to keep supply in check even after the current round of production cuts.
When you put all this different information together, you get rising oil and gas prices and rising stock prices for Core Labs, Helix and Transocean. The only problem is that one day there won’t be a trend, and honestly, this is a complex and dynamic time in the energy industry. In normal times in the volatile energy sector, it is as likely that prices will fall as they rise over short periods of time. Today, investors are even more volatile. What makes this trio of shares even more difficult is that the shares of energy service companies tend to move more dramatically than the shares of their largest customers. In other words, investors should be prepared for increased price volatility at Core Labs, Helix and Transocean. Most investors who are bargain hunting in the energy sector today should probably look to large diversified drilling companies like Chevron, which also happens to have one of the strongest balance sheets in the industry.