Why U.S. Shale Stocks Are Ailing (XOP, XES)

The U.S. oil market was decidedly under-whelmed by last week’s OPEC and Non-OPEC ministerial meeting. Oil prices closed the week down nearly 1.5% after having been up by as much as 2.7% as late as Thursday. OPEC and Non-OPEC producers approved a nine-month extension of the 1.8 million barrel per day reduced production agreement reached in November last year. Oil traders signaled they expected deeper cuts when oil prices began to slide shortly after details emerged.

The concern is that a mere extension of the production adjustments will prove insufficient to reduce the high levels of global oversupply in the oil market. Market participants were betting on deeper and more meaningful adjustments to remove excess oil barrels from the market. (For more, see: Is Oil Forever Stuck at $40 to $60 Per Barrel?)

U.S. Shale Still Pumping Away

Market expectations for this agreement were high because of anticipation that U.S oil production will keep rising for the rest of the year. Many American shale producers were able to hedge up to 30% of their production at higher oil prices that resulted from last year’s initial production adjustment agreement. This allows them to keep the taps on even if oil prices take another dip lower, adding to an already oversupplied market.

Another concern is the large number of new projects coming on line outside of the U.S. in the next five years. As this chart shows, nearly 1.8 million barrels per day is expected to come to market in 2017 alone, which completely offsets the production taken offline by OPEC and its partners. With so much pent up supply it is easy to understand why the market may doubt a quick end to the current global oil glut.

Equity Price Performance

This concern is also reflected in the poor equity price performance of various oil companies across the value chain. For example, the SPDR S&P Oil & Gas Exploration and Production ETF (XOP) and the SPDR S&P Oil & Gas Equipment and Services ETF (XES) are down 17.9% and 26.9% respectively in 2017. This is quite an under-performance considering oil prices are down just 7.3% for the year so far.

Much of this under-performance is coming from market concerns that oil prices are just high enough for U.S. shale oil companies to service their debt obligations and stay in business, but are not necessarily high enough to fund growth or pay a dividend. Pressure on dividend payments or doubts about the growth story tend to weigh most heavily on equity price performance.

Even in the debt space, the current oil price seems to be a thin buffer for many in the sector. For example, S&P Global Ratings reported that out of the 44 U.S. high yield companies to default so far in 2017, nearly one-third of them are in the oil and gas sector. These defaults make oil and gas the worst performing sector in S&P’s 2017 default cohort. (For more, see also: Energy Sector in Hot Water, Defaults Keep Rising.)

Disclaimer: Gary Ashton is an oil and gas financial consultant who writes for Investopedia. The observations he makes are his own and are not intended as investment advice.

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