What happened
The oil market snapped a two-session losing streak on Tuesday, rallying nearly 2% and pushing the U.S. WTI oil-price benchmark up above $48 per barrel. Fueling the buying were traders betting that oil inventory data will show a deeper decline than the market's current projections of a 3.5 million-barrel drop in supplies. Driving that expectation for a bullish report is high compliance with the OPEC-led production cuts, strong refining throughputs, and robust oil exports.
This bullishness spilled over into oil stocks, with the weakest links experiencing the biggest gains. Sanchez Energy (NYSE: SN), California Resources (CRC), and Denbury Resources (DNR) all closed up BY double digits on the day, while SM Energy (SM -2.18%) rose nearly 9% at one point on the day.
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So what
In the grand scheme of things, a 2% rebound in the oil market is pretty tame. However, for beaten-down oil stocks like Sanchez Energy and Denbury Resources, which are down 25% and 55%, respectively, this year even with today's bounce, any good news is worth celebrating. That's because both companies need higher oil prices to thrive. In Sanchez Energy's case, it made a big bet on a crude-oil rebound when it invested more than $1 billion to bolster its position in the Eagle Ford Shale earlier this year. It's a gamble that requires $55 oil to pay off otherwise the company won't be able to grow into its balance sheet as quickly as anticipated. Denbury Resources, meanwhile, needs the cash flow from higher oil prices to support its capital plan, which would finally reverse its production decline. Otherwise, if crude oil doesn't cooperate, Denbury might need to cut spending, which could cause its output to continue heading south.
SM Energy and California Resources, likewise, have been under tremendous pressure this year because oil prices have remained stubbornly below $50 a barrel, which is why both stocks are down about 45% since the start of the year. In California Resources' case, it has so much legacy debt that even at $55 oil, its leverage ratio will remain at more than 7.0 times debt-to-EBITDA during the next two years. For perspective, Sanchez Energy's growth plan would get its leverage below 3.0 next year at $55 oil, which is still high for an oil company in the current market.
Meanwhile, lower oil prices this year torpedoed SM Energy's plan to sell its oil assets in North Dakota to reduce debt, which forced the company to postpone that process. While the company did have some positive news today after it increased production guidance because of positive well results, it needs higher oil prices so it can balance cash flow with capex, or else it risks drilling itself deeper into debt.
Those higher oil prices might be in the cards if supply data continues to show declining oil stockpiles. That would suggest that OPEC's cuts are working, which should eventually stabilize oil prices at higher levels once the market fully rebalances. Those higher prices would help put these producers back on solid ground.
Now what
With crude oil turning higher, beaten-down oil stocks enjoyed a bit of a relief rally today. That said, today's gains could be gone tomorrow if the data isn't as bullish as expected. These oil stocks desperately need higher oil prices to fuel their operations, which is why investors should steer clear of this group, especially since there are better oil stock options out there.
