What happened
Shares of U.S. oil and natural gas exploration and production (E&P) company Centennial Resource Development (PR) rose a quick 6% in the first half hour of trading on Oct. 5. That gain didn't hold, however, with the stock sitting at a roughly 3.5% gain by around 10:30 a.m. EDT.
So what
Centennial's top and bottom lines depend heavily on the price of the commodities it produces. Oil and natural gas, however, have a tendency to be volatile and, at the moment, are hovering at relatively low levels. In fact, it's hard for many E&P names to turn a profit right now. The quick advance in the stock price was likely driven by a sizable jump in the price of oil and natural gas, which makes complete sense. But that isn't the whole picture.
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Even after today's sizable price gain, West Texas Intermediate Crude, a key U.S. oil benchmark, is still trading below $40 per barrel, and natural gas also remains historically low. This is not a great environment for drillers, particularly small ones with a lot of leverage. Centennial's market cap is just $170 million and its financial debt-to-equity ratio is a weighty 4.5 times or so. Rising energy prices are good to see, particularly since the sector ended last week on a weak note. But the headwinds facing Centennial haven't changed one bit, which Wall Street seems to have quickly recognized following a brief burst of excitement.
Now what
Centennial Resource Development is operating in a difficult environment and from a position of relative weakness (it's small and leveraged). Most investors looking at the energy sector would likely be better off with a larger company that has a stronger financial foundation. A good starting point on that score would be Chevron, which is one of the largest, most diversified, and most fiscally prudent integrated oil majors you can find right now.
