While oil prices are notoriously volatile, the past six months have been extreme. The U.S. oil price benchmark, West Texas Intermediate, peaked early last October at more than $75 a barrel. Less than three months later it was in the mid-$40s, a 40% plunge from the top. It has since reversed course, rocketing 32% during the first quarter of 2019 to right around $60 a barrel.
That's the biggest quarterly rebound in the price of oil since 2009. It's also great news for oil producers, which based their capital spending plans on oil averaging around $50 a barrel this year.
What's fueling the rebound in oil prices?
Oil collapsed last fall because of an abrupt shift in sentiment. The oil market had spent most of the summer fretting that there wouldn't be enough oil to meet demand because the U.S. promised to impose powerful sanctions on Iran. The Trump administration, however, unexpectedly granted waivers to most of Iran's key buyers. As a result, the market had more oil than it needed, which caused crude prices to plunge.
That forced OPEC to shift its policy and reduce supplies for the first half of 2019. The OPEC-led production reduction, when combined with output issues in Venezuela and healthy demand growth, have helped quickly rebalance the oil market. That has propelled oil prices back above $60 a barrel.
Benefiting from the big rebound in crude oil
The rebound back around $60 a barrel is a boon to some oil producers and a blessing to others. Large, low-cost oil producers including ConocoPhillips (NYSE:COP) and Occidental Petroleum (NYSE:OXY) spent the past few years resetting their businesses to run at lower oil prices. As a result, they only need oil to average around $40 a barrel to provide them with the cash flow to sustain their current production rates and pay their dividends. ConocoPhillips and Occidental Petroleum can generate enough money at $50 a barrel to grow their output at a mid-single digit rate. Meanwhile, they can produce an increasing supply of excess cash above that level, which they could use to repurchase shares or drill more wells. Occidental, for example, can grow output by 11% to 13% at $60 oil compared to 8%-10% if it averages $50 a barrel.
For other oil companies, the rebound in the oil market is an unexpected blessing. Smaller producers Denbury Resources (NYSE:DNR) and Chesapeake Energy (OTC:CHKA.Q), for example, aren't able to thrive at $50 a barrel like their larger peers, in part because of their weaker financial profiles. That's why both companies cut spending this year in response to the crash in crude at the end of 2018.
In Denbury's case, it plans to invest 20% to 25% less than last year. It's a deep cut that will cause Denbury's production to fall 4% this year. However, it will also enable the company to generate $50 million to $100 million in free cash (assuming oil averaged $50 a barrel) to help pay down debt. Though now with oil bouncing back into the $60s, Denbury is on pace to haul in $125 million to $175 million in free cash, which would help put a bigger dent in its debt load.
Chesapeake Energy, meanwhile, reduced its rig count 20% this year. Though even with that reduction the company anticipated that it would slightly outspend cash flow this year to grow production. However, with oil prices surging, that gap could disappear. That would enable the company to achieve its long-standing goal of living within its means.
2019 is turning out to be a better year for oil stocks than expected
The late collapse in crude prices during 2018 cast a shadow on 2019. It led many oil companies to keep a firm lid on spending so that they could run on lower oil prices. However, with crude bouncing back into the $60s, these oil producers are on track to generate much more cash than they expected this year. That will provide stronger oil companies with the funds to drill additional wells or buy back more shares while giving the weaker ones the money to bolster their financial profile, which could help propel their stock prices in the coming months.