Why Shares of National Oilwell Varco Dropped 20% in December

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What happened

Shares of oil equipment manufacturer National Oilwell Varco (NYSE: NOV) fell 20% in December, according to S&P Global Market Intelligence. Much of that plunge can be chalked up to general market declines and dropping oil prices. The long-term concern, though, is that these events may further put off oil and gas capital spending that oil services companies have been anticipating for years.

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So what

National Oilwell Varco makes its hay from oil producers' capital expenditure budgets. Any piece of equipment a producer needs for extracting oil and gas -- from drill bits to floating production storage and offloading vessels -- chances are National Oilwell Varco makes it. Even though it has a dominant market share in big-ticket items like offshore drilling rig packages, its prospects will still wax and wane based on how much money producers are putting into new production.

That hasn't been the best business to be in over the past several years because, well, producers haven't been spending money. Either they drastically cut their budgets, or they opted to improve the performance at existing sources rather than develop new reservoirs.

National Oilwell Varco's management has been saying for some time that it anticipates an uptick in spending over the next few years. The number of new projects slated to produce first oil over that time may not be enough to offset declines from existing sources and meet new demand. It anticipates double-digit revenue growth between now and 2021 with oil around $65 per barrel.

Unfortunately, oil prices have dropped considerably since that forecast, and lower oil prices could further delay expected capital spending. If that is the case, National Oilwell Varco's results could continue to be underwhelming.

Now what

National Oilwell Varco is an incredibly well-run business in a brutal industry (full disclosure: I own the stock and have spoken at length with management). The market for oil and gas has been and will likely continue to be a cyclical one. What's more, North American shale drilling can turn on and off so quickly that it has thrown a whole new dynamic into the industry that makes it even harder to predict. Within the past 18 months, we have seen oil prices increase from $50 a barrel to as high as $85, then drop right back to below $50 again.

That kind of volatility and unpredictability is likely going to make many producers more cautious when building their capital spending budgets, which will, in turn, directly impact National Oilwell Varco's bottom line. While I have little doubt that management will be able to work through these tough times, it's hard to say how much these wild oil price fluctuations will impact future capital budget decisions.

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Tyler Crowe owns shares of National Oilwell Varco. The Motley Fool owns shares of and recommends National Oilwell Varco. The Motley Fool has a disclosure policy.