What happened
Oil prices are bounding higher on Tuesday, with WTI, the leading U.S. oil benchmark price, surging more than 4% to nearly $45 a barrel by 10:45 a.m. EST on Tuesday. That pushed WTI to its highest level since August. Fueling the rally in oil prices was news this week that a third vaccine against COVID-19 had an efficacy rate of up to 90% in a late-stage clinical trial. That's driving optimism that the global economy can quickly normalize in the coming months, which would drive up demand for crude oil.
The surge in oil prices is propelling oil stocks today. Industry behemoths ExxonMobil (XOM +0.65%) and ConocoPhillips (COP +1.34%) both rallied more than 5% in early-morning trading. Meanwhile, shares of smaller oil producers like Apache (APA +0.38%), Centennial Resource Development (CDEV 0.20%), and QEP Resources (QEP +0.00%) all surged more than 10% at one point on Tuesday.
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So what
The COVID-19 outbreak has had a devastating impact on oil demand this year because it shut down large swaths of the global economy. That had a significant effect on the oil market, forcing OPEC into a historic agreement to curb production. That pact helped stabilized the oil market, giving demand time to recover. While consumption remains well below its prepandemic peak, it could accelerate in 2021 as vaccines start slowing the spread of the virus, giving people more freedom to travel for work and leisure. That would likely push crude prices up even further, boosting oil company cash flows.
Exxon needs higher oil prices to balance its expected cash outlays next year with its projected cash flows. According to one analyst, the company faces an $8 billion shortfall in funding its dividend and capital spending in 2021 under the assumption that WTI averages $47 a barrel. However, at $55 a barrel, the company would be in a much better position to fund its dividend and grow its production and cash flow.
ConocoPhillips is already in a solid position, even more so after agreeing to acquire rival Concho Resources. That deal keeps its average supply cost below $30 a barrel, which has it on track to generate significant free cash flow if oil prices continue improving. That would enable the company to repurchase more shares or pay special dividends with the excess cash.
Meanwhile, smaller producers like Apache, Centennial Resource Development, and QEP Resources are in a similar boat as Exxon. They need higher oil prices to generate the cash flow required to support their operations. Apache only expects to invest $1 billion or less on capital projects next year if oil prices are at $40 a barrel, which would impact its ability to grow production. Centennial needs higher oil prices to boost its cash flow after its liquidity almost ran dry earlier this year when prices plunged. Finally, like Centennial, one of QEP Resources' main objectives in recent months has been staying afloat by paying off debt. If oil prices keep rallying, these producers will have more cash to fund new drilling and shore up their financial situations.
Now what
There's growing optimism that we're near the beginning of the end of this pandemic. That's fueling the belief that the global economy can return to normal in the coming months. That would drive oil demand higher, likely taking crude prices up with it. Those higher prices would help cure what ails most oil companies as they need further improvement to generate more cash to fund development programs, dividends, and debt retirement.
