What happened
Shares of small U.S. oil and gas company SM Energy (SM +3.75%) rose as much as 11% on Sept. 16. Fellow driller Occidental Petroleum (OXY +4.03%) were up roughly 10% at one point. Drilling services provider Core Laboratories (CLB +0.00%) also joined the energy sector uptick, rising around 9%. All three had given back some of their gains by 1 p.m. EDT, but were still holding on to high-single-digit advances.
So what
Each of the sizable daily advances here is owed, in great part, to a notable rise in the price of oil today. But to attribute the entirety of the moves to this single factor would miss the bigger picture. Oil prices have fallen to painfully low levels in 2020 because of the dramatic reduction in demand that resulted from the economic shutdowns used to slow the spread of COVID-19. It was so bad that, at one point, oil fell below zero. Although economies around the world are opening up again and oil prices have risen well off the zero bound, they remain mired at a level that makes it difficult for exploration and production companies to turn a profit. That's partly because of weak demand and partly because excess supply earlier in the year has created an overhang of oil sitting in storage. This backdrop is vital to understanding the situations in which Core Labs, Occidental Petroleum, and SM Energy find themselves today.
Image source: Getty Images.
This is a difficult environment for any energy company, but particularly for an energy services name like Core Labs. With oil prices low, demand for the company's data-focused reservoir services has been weak as drillers pull back to save money. To be fair, it's not unusual for such a business pullback in this highly cyclical industry, but this downturn is particularly deep and came swiftly due to COVID-19. Even after the sizable gain today Core Labs stock is still off roughly 50% so far in 2020. Core Labs' business is asset-light (notably it does not own drilling rigs) and it has a reasonable financial debt-to-equity ratio of 0.3 times, so it should muddle through this period in relative stride. However, it still tends to rise and fall along with investor enthusiasm for oil because its fortunes are tightly entwined with those of black gold.
Oil driller Occidental Petroleum is in an entirely different situation. The company beat out Chevron in a bidding war for Anadarko Petroleum, using debt to fund the purchase. Occidental's purchase of Anadarko turned into a disastrous acquisition once oil prices started to tumble. At the end of the second quarter Occidental's financial debt-to-equity ratio was a hefty 1.4 times. That's not unmanageable, but low oil prices will make working down leverage very difficult. In fact, its plans to sell assets so it can pay down debt have basically hit a brick wall in 2020. With a number of near-term debt maturities coming up, things may get a little tight before they get better. That said, generally speaking, bond investors still appear willing to work with highly leveraged companies -- for the right price. Higher energy prices would clearly make the future easier for Occidental, so it makes sense that investors gave the shares a boost today along with the price of oil.
CLB Financial Debt to Equity (Quarterly) data by YCharts
SM Energy is a small U.S. onshore driller, sporting a market cap of just $230 million or so. The story here isn't nearly as exciting as the one behind Occidental, but the core of the issue is pretty much the same. SM Energy's financial debt-to-equity ratio was a hefty 5.7 times at the end of the second quarter. Onshore drillers have long made heavy use of debt to fund their exploration efforts, so SM Energy's leveraged approach to the sector is hardly unique. In fact, it can work out very well when oil prices are high, but when energy prices are low, like they are today, debt can become a significant burden. Higher oil prices would clearly help SM Energy survive through this downturn and, thus, its shares tend to pop when oil rises.
Now what
Oil is a commodity prone to big price moves, and news (such as a hurricane working its way through the Gulf of Mexico region) can result in swift rises. But there are many things that can result in them quickly falling lower again. Today's oil advance lifted the shares of Core Labs, Occidental, and SM Energy and there's good reason for that. However, it's difficult to suggest that oil's advance today really changes anything about the bigger supply/demand imbalance or the headwinds that these specific energy names are facing right now. Core Labs, Occidental, and SM Energy are not stocks for the faint of heart, as more volatility is highly likely.
