Russia's Refusal to Consider Deeper Production Cuts Upends Crude Oil's Winning Streak

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What happened

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The oil market's longest winning streak in 10 months came to an abrupt halt Wednesday. After rising in each of the past eight trading sessions, crude tripped over comments by Russia that it would oppose deeper supply cuts beyond its existing agreement with OPEC. Those remarks, along with data showing rising OPEC exports and a stronger U.S. dollar, knocked crude down 4.1% on the day to around $45 a barrel, which was its biggest drop in a month.

The sell-off in the oil market hit shale-focused stocks hard. According to data from S&P Market Intelligence, shale drillers Whiting Petroleum (NYSE: WLL) and Carrizo Oil & Gas (NASDAQ: CRZO) led the way down, both slumping more than 10% on the day. Meanwhile, frack sand producers and service companies also sold off on the news, with Fairmount Santrol (NYSE: FMSA)Smart Sand (NASDAQ: SND), and Nabors Industries (NYSE: NBR) dropping around 10% on the day.

So what

Russia's instance that it won't reduce its output any further could force shale drillers to start pulling back on their growth plans. One of the most likely shale drillers to pull the plug on its growth ambitions is Whiting Petroleum. The Bakken Shale-focused driller currently plans to spend $1.1 billion on new wells this year, which is nearly double what it spent last year. As a result of that spending increase, the company expects its production to rise 24% by the end of the year. That said, Whiting Petroleum needs oil to average $55 a barrel to finance that plan within cash flow. Given where the price of crude is these days, and the fact that it has $1.5 billion of debt maturing in the coming years, analysts expect the company to scale back on its plans, so it doesn't drill itself any deeper into debt.

Carrizo Oil & Gas is another shale driller that's planning to grow aggressively this year despite a weak balance sheet. Initially, the company planned to boost its oil output 27% this year, despite having a net debt-to-EBITDA ratio of 3.3 times at the end of the first quarter, which is well above the 2.0 times industry average. Carrizo Oil and Gas has since increased that growth guidance to 39% after announcing a $648 million acquisition, which it partially financed by issuing another $250 million high-yield debt. Given that the company is outspending cash flow at current oil prices and it has a stretched balance sheet, Carrizo might need to pull back on its growth plans, especially since Russia won't cut any more production to provide additional support for oil prices.

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The industry faces a catch-22 at the moment. Shale drillers need to start pulling back on completing new wells to boost oil prices since Russia and OPEC are unlikely to provide additional support. However, if shale drillers do pull back, it will likely tamp down demand for frack sand produced by Fairmount Santrol and Smart Sand as well as for Nabors Industries' fracking services. That would be bad news for these companies because Fairmount Santrol and Smart Sand had hoped that demand would continue growing, which would enable them to raise prices. Likewise, Nabors Industries needs demand for its services to keep growing so it can also push through price increases and boost profitability.

Now what

Shale drillers had been holding out hope that the Russian-OPEC alliance would cave in and reduce their output further to boost prices so that U.S. drillers won't have to slow their drilling pace. However, with Russia refusing to consider a deeper cut, it's growing more likely that shale drillers will need to slow their pace, which would cause demand for frack sand and fracking services to fall. Given this uncertainty, investors are better off steering clear of financially weak producers and service providers at the moment because they'll likely feel the brunt of any future pullback in shale drilling.

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Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.