What happened
Shares of Vermilion Energy (VET 0.50%), a globally diversified Canadian energy company, rocketed higher by 15% as of noon today. Unfortunately, the stock remains sharply lower for the year, having fallen roughly 75% from its January highs. That share price decline, not surprisingly, was driven by sharply lower oil prices. The big gain today was driven by rising oil prices.
So what
Global oil prices have been incredibly volatile in 2020, pushing the shares of drillers dramatically higher and lower on a day-to-day basis. The big picture here is that growing U.S. production over the past decade or so has upended the historical supply-and-demand dynamics in the oil market. Although OPEC had been cutting production to deal with the issue, OPEC and Russia had a falling-out over this approach and effectively got into a price war, adding even more supply to the market. Then, efforts to contain COVID-19, notably through the closure of economies around the world, led to a rapid and dramatic decline in demand.
Image source: Getty Images.
Supply materially outstripping demand has led to a painful drop in oil prices and a massive buildup in oil sitting in storage tanks. To deal with the financial hit, Vermilion trimmed its capital spending plans by roughly 20% in mid-March and reduced its monthly dividend by 83%.
Just one month later, on April 15, the dividend was eliminated entirely, removing one of the main reasons investors owned the shares in the first place. Although management expressed how important returning capital to investors is, it noted that preserving its financial flexibility in uncertain times is the primary goal today.
Oil prices have rallied over the last couple of days, somewhat ironically, because investors believe the pain in the energy sector is going to lead to notable production declines. Once economies around the world reopen, that reduction will allow excess inventory to be worked down. And eventually, oil prices can head sustainably higher. In that scenario, Vermilion would likely start paying a dividend again sooner rather than later.
Now what
Oil markets are highly volatile under normal conditions and even more so today with the COVID-19 pandemic. Vermilion investors have been hard hit by the uncertainty, both with regard to the company's dramatic stock decline and its elimination of the dividend. If oil prices move higher in a sustained fashion, Vermilion will clearly benefit.
But even in a best-case scenario, a return to more-normal supply-and-demand dynamics will take some time. Income-focused investors shouldn't expect a quick resumption of the dividend at Vermilion. This oil driller remains a speculative investment.
