What happened
Shares of U.S. energy giant Occidental Petroleum (OXY +1.19%) rose as much as 27% in early trading on Nov. 9. Small U.S exploration and production company Centennial Resource Development (CDEV +2.84%) wasn't far behind with a 21% advance. Energy services provider Core Laboratories (CLB +0.00%) matched that gain, rising 21% as well.
Although all three of these energy names managed to cling to their gains, there was a slight deviation in direction at roughly 1 p.m. EST. Core Labs was sitting close to its daily high, with a 20% advance. But the rallies in the stocks of Occidental and Centennial had cooled some, with the pair up 20% and 13%, respectively. That said, the news that drove this trio higher may not be quite as good as investors hope.
Image source: Getty Images.
So what
A little background is needed here to understand what's going on today. Supply was exceeding demand in the energy sector before the global pandemic. The main driver of the excess was a decade of increasing supply out of the U.S. onshore market. When COVID-19 started its rapid spread across the world, governments chose to effectively shut their economies. That resulted in a swift and drastic reduction in demand. So a slightly oversupplied market became a hugely oversupplied market. The excess energy production, meanwhile, wound up in storage, putting further downward pressure on oil and natural gas prices. It got so bad that at one point earlier in 2020 the key U.S. oil benchmark West Texas Intermediate fell below zero.
Since no company can survive if it has to pay customers to take its oil, it shouldn't be a shock that the energy sector pulled back quickly. Production was curtailed and capital spending was drastically reduced. Although oil prices have risen from their lows, they remain at levels that make it difficult for energy companies to turn a profit. It's not a pretty situation and many energy companies are down for the year. Even after today's big gains, Core Labs has lost half its value so far in 2020, Occidental is off by around 70%, and Centennial is down by 85%.
The big news that has investors excited today is on the coronavirus front. Pfizer and partner BioNTech announced that they had achieved material success with their vaccine offering. That is very good news from a big-picture perspective, since it means that there is a light at the end of the pandemic tunnel. Indeed, things may, some day, go back to a more normal state. That, in turn, would mean increased demand for oil and natural gas and, thus, higher prices for these vital global fuels.
However, investors need to keep this news in perspective. Nothing will change until a vaccine is officially approved and widely distributed. And that is going to take more time -- likely months or even years. So while the vaccine news is great to hear, it probably won't solve any near-term problems for Occidental, Centennial, or Core Labs.
And there are very big issues for this trio to deal with. Occidental made news in 2019 when it outbid Chevron to buy Anadarko Petroleum. That investment, funded largely with debt, wound up being a weight around the company's neck when oil prices plummeted. Although it is making progress dealing with the aftermath of the ill-timed acquisition, it's still not out from under this decision just yet. Centennial Resources, like many of its fracking peers, made extensive use of leverage to fund its drilling efforts. When prices fell that debt turned into an albatross that has made funding its business far more difficult. This is no small issue, noting that Centennial's financial debt-to-equity ratio is a troublingly high 6.5 times. Occidental, for reference, comes in at roughly 1.5 times with Chevron at a very modest 0.25 times. Meanwhile, Core Labs provides well enhancement services to energy companies, which saw demand dry up as drillers pulled back. Until its customers start drilling in larger numbers again, performance is likely to remain weak. In fact, there's likely to be a lag between the time that oil prices improve and when oil and gas companies start to increase capital spending.
Now what
There's no question that the vaccine update is good news. But there's still a lot that needs to be done before this news translates into sustained improvement in the energy sector. It's worth remembering, too, that there continues to be excess supply in the system because of all of the oil and gas that's sitting in storage. So, even after the world starts to return to normal activity, energy prices may continue to face headwinds for a little while until all of that stored energy gets worked off. In other words, today's price advance in the energy sector, including the big stock gains at Occidental, Centennial, and Core Labs, is probably a bit ahead of the curve.
