What happened

Shares of exploration and production company Oasis Petroleum (NYSE:OAS) rose nearly 25% in early trading on July 1. The stocks of fellow energy players Northern Oil & Gas (NYSEMKT:NOG) and Centennial Resources (NASDAQ:CDEV) advanced roughly 11% and 9%, respectively. By 10:30 a.m. EDT, all three had pulled back from their highs, with Oasis up a still impressive 14.5%, Northern 6.5%, and Centennial 4%.

So what

There was no specific news released by any of the companies here that would have precipitated their stock moves. However, oil prices were up in early trading. And since each of the companies relies on this highly volatile commodity to power its top- and bottom-line results, the uptick in oil helped push a more positive mood among investors in the stocks. This is simply par for the course, with energy stocks in general showing a great deal of volatility of late. 

A woman in front of oil wells

Image source: Getty Images.

Oasis is probably the best example of that volatility from this trio of names, being that its stock was up more than 300% at one point over the past month, but is now up "only" 85% or so over that span. Sure, an 85% price gain in a month is pretty good, but it's still down nearly 60% from its most recent highs. The same is true of Centennial Resources, with Northern Oil & Gas "only" about 25% below its most recent highs. If you are going to invest here, expect this kind of volatility to continue.   

One of the key reasons for this is that these companies, and many more in the energy patch, are trying to muddle through a difficult market while carrying a material amount of leverage on their balance sheets. To put some numbers on that, Centennial's financial debt-to-equity ratio was troublingly high at 13.5 times at the end of the first quarter. Oasis wasn't far behind with a roughly 9.5 times ratio. Northern Oil & Gas looks the best positioned here, with its financial debt-to-equity ratio sitting at just under four times. 

OAS Financial Debt to Equity (Quarterly) Chart

OAS Financial Debt to Equity (Quarterly) data by YCharts

However, Chevron (NYSE:CVX), which has a material position in the onshore U.S. space and offers a generous 5.7% dividend yield (the other companies here do not pay dividends), has a financial debt-to-equity ratio of just 0.25 times. While it's not completely fair to compare tiny E&P penny stock names with an industry giant like Chevron, investors looking for U.S. onshore exposure should really step back and consider the risk differences here. There's a very real chance that the energy downturn pushes smaller U.S. drillers out of business, especially those with heavy debt loads. Relatively large Chesapeake Energy is the most recent example of this trend, noting that its financial debt-to-equity ratio was roughly 4.8 times at the end of the first quarter. In other words, it may be safer to invest in a large and financially strong oil company that's more diversified, including some exposure to the U.S onshore space, than to place what could end up being an all-or-nothing bet on a small fry with a leveraged balance sheet.

Now what

Higher energy prices are likely a necessity for Oasis, Centennial, and Northern Oil & Gas if they want to muddle through this downturn. If prices stay low or fall anew, they may not be able to survive without taking a trip through bankruptcy court. So it's no surprise that their stocks would rally along with oil. The bigger question for investors is if the risks here are worth the rewards or if it would be more prudent to err on the side of caution and go with a company like Chevron. Regardless of what you decide, however, expect volatility to remain high until there's a clear and sustained uptrend in the price of energy. That, unfortunately, doesn't appear likely in the near term.