What happened
What a difference a day makes. The oil market was downright giddy on Tuesday, rebounding after traders made a bullish bet on government data. Yesterday, however, crude prices rolled over when that data turned out to be the opposite of what it expected. Instead of falling by more than 3.5 million barrels, which is what the market anticipated, crude oil inventories rose by 3.3 million barrels, according to a report by the U.S. Energy Information Administration. That report upended the oil market, sending crude down nearly 5% to below $46 per barrel and matching its low for the year.
That sell-off had a devastating impact on financially strapped oil companies. After rallying double-digits on Tuesday's bullish buying spree, SM Energy (SM 0.12%), Denbury Resources (DNR), California Resources (CRC), and Sanchez Energy (NYSE: SN) gave back those gains by dropping more than 10% by the midafternoon on Wednesday. These oil stocks had plenty of company, with WPX Energy (WPX), Whiting Petroleum (WLL), Oasis Petroleum (OAS) and Callon Petroleum (CPE) also plunging by double digits.
Image source: Getty Images.
So what
In covering Tuesday's rally, I cautioned investors that "today's gains could be gone tomorrow if the data isn't as bullish as expected." Those words proved prophetic given that the government data was downright bearish, which is deeply concerning for the first set of oil producers because each is still trying to get back on its feet after the devastating impact of the market's downturn over the past few years. Meanwhile, that second group got crushed yesterday because they bet big that oil prices would be higher this year, by ratcheting up spending to grow production.
Whiting Petroleum, for example, set its capital budget at $1.1 billion this year, which would roughly match expected cash flows at $55 oil. That budget represented double the money it spent last year, enabling it to finance enough rigs to increase production 23% by the end of this year. That said, with crude oil now well below that mark, Whiting is on pace to significantly outspend cash flow, which isn't something it can afford to do since it has $1.5 billion of debt maturing over the next few years. Because of that, it might need to cut is budget, so it doesn't drill itself deeper into debt.
Lower oil prices could also prove problematic for Bakken Shale-focused Oasis Petroleum. The company had been planning to double its rig count there to four by the middle of this year, while also redeploying a second well service crew in the second half, which would help it deliver 15% production growth in 2017 and 2018. While Oasis Petroleum expected to be able to achieve that growth while living within cash flow, given crude crumbling, its cash flow won't be as high as anticipated, which might force it to tap the brakes on those growth plans.
WPX Energy is another oil producer that had planned to aggressively grow oil production so it could take advantage of higher prices. The company anticipated that it would increase oil output by 25% and 50% in 2017 and 2018, respectively, under the assumption that crude would average $50 and $55 in those years. This growth would put the company on pace to be free cash flow positive by the end of next year. That said, with crude now stubbornly below $50 a barrel, WPX Energy might need to rethink its growth plan so that it doesn't tack on too much more debt by outspending cash flow.
Callon Petroleum is another producer with an ambitious growth plan. The company is planning to increase output by more than 10% per quarter, which puts it on pace to exit next year producing 40,000 barrels of oil equivalent per day -- or double where it expects to end this year. However, that growth plan requires Callon Petroleum to outspend cash flow by a wide margin, meaning it will need to take on more debt. Given the direction crude prices have been heading, that doesn't appear to be a wise decision (and one it might need to rethink).
Now what
Shale producers saw the OPEC-led production cuts as their signal that it was time to ramp spending and grow production. The problem is that too many producers were overly aggressive in their projections, with many planning to vastly outspend the cash flow they expected to generate even at higher oil prices. It's a decision that's coming back to bite them, as oil inventories aren't draining, which is putting more pressure on oil prices. It's pressure that likely won't abate until producers take their foot off the gas, and slow their current growth pace to match capex with cash flow at lower crude prices.
