What happened
The U.S. oil price benchmark WTI is bouncing back a bit today after crashing to an 18-year low of around $20 a barrel yesterday. That's helping fuel a rally in most energy stocks. Shares of several U.S. producers jumped more than 10% by noon EDT on Tuesday, including Devon Energy (DVN +1.31%), Parsley Energy (PE +0.00%), Diamondback Energy (FANG +0.33%), and Apache (APA +3.96%).
So what
One reason WTI is higher today is that U.S. producers are contemplating a coordinated effort to reduce their output in the near term to help combat the demand destruction caused by the COVID-19 outbreak.
Image source: Getty Images.
Several producers have already announced budget cuts following the collapse of oil prices in recent weeks. Devon Energy, for example, sliced $500 million out of its budget a couple of weeks ago and then reduced it by another $300 million this week, slashing it by 45% overall. Diamondback also made two budget-reduction announcements, cutting its spending plan by 40% overall. Apache, meanwhile, made one deep 40% cut a few weeks back.
These budget reductions, however, won't have an immediate impact on output. That's because these companies are only slowing their activity levels, meaning they won't complete as many new wells as initially expected this year. That will have some effect on production in the future as the output from legacy wells declines and not enough new ones come online to replace that lost output.
Diamondback Energy, for example, said today that its spending cuts this year would cause its daily average oil production rate to be about 3.5% below where it exited 2019. However, slight declines like that won't solve the industry's most pressing near-term problem, which is lack of storage space due to the COVID-19 outbreak's impact on demand.
That's leading some producers to push for even deeper industrywide cuts. Parsley Energy and Pioneer Natural Resources (PXD +0.00%) are leading that charge by jointly sending a letter to Texas' oil regulator to push for an emergency meeting to consider curbing output in the state, according to a report by Bloomberg. They're seeking a 20% reduction in Texas' oil output to help ease the glut of crude that's piling up in storage terminals.
In addition to that push from within the industry to curb production, President Trump recently spoke with Russian President Putin about working together to stabilize the oil market. They agreed to have their energy ministers begin talks, which could result in a coordinated production cut by those countries.
U.S. oil producers desperately need higher oil prices to survive. While many companies have oil-hedging contracts in place at higher prices to lock in some of their cash flow, most will expire by the end of this year. If prices don't improve, they won't generate enough cash to operate, which could cause a wave of bankruptcies in the coming quarters. That's why the industry and governments are discussing whether they can work together to get through this period of low demand from the COVID-19 outbreak so that excess supplies don't overwhelm the system.
Now what
Oil stocks in the U.S. are bouncing back on the hope that the industry will go a step further and start cutting production. While there's growing calls within the sector to take this action, there's no guarantee that everyone will come together in a coordinated agreement. Because of that, it's too risky for investors to consider buying shares of oil producers right now since things could get much worse.
