What happened
Shares of $14-billion-market-cap exploration and production company Occidental Petroleum (OXY 0.31%) rose a dramatic 72% in November, according to data from S&P Global Market Intelligence. That massive increase, however, was smaller than what relatively-tiny $740-million-market-cap offshore driller Kosmos Energy (KOS 1.17%) saw, with its stock rallying 77%. Even smaller Callon Petroleum (CPE), with a $420 million market cap, witnessed a nearly-82% share price gain in the month. Those are astronomical numbers for such a short period of time -- but not a whole lot has actually changed at these energy companies.
So what
The big story in November was the release of upbeat coronavirus vaccine news. Specifically, vaccine offerings from Pfizer and BioNTech, AstraZeneca, and Moderna all achieved high rates of success in fighting off the scourge behind the global pandemic. Investors, seeing these results, looked forward to a time when the world would move past the coronavirus. And thus names that were facing material headwinds because of COVID-19 rallied. To some degree that makes complete sense, but investors also have a habit of letting their emotions get ahead of the actual events taking place on the ground.
Image source: Getty Images.
For example, the deep drop in oil prices was the result of the demand decline driven by global efforts to slow the spread of the coronavirus via forced economic shutdowns. Yes, a vaccine will likely help to restore demand, but the supply/demand imbalance is quite large. And it's important to remember that the oil not used earlier in the year was put into storage -- so even as demand comes back, there's still likely to be a material supply overhang that lingers for a while longer and keeps a lid on oil prices.
And then there are the individual companies. For example, Occidental's issues are directly tied to oil prices, but they go beyond that one factor. Indeed, the real damage from low oil prices was how they made it harder for the company to pay for the debt-fueled acquisition of Anadarko Petroleum in 2019. It's making progress as it tries to absorb what in hindsight was an ill-timed acquisition, but it still has a long way to go before this misstep is behind it. Higher oil prices would help, obviously, but they won't be an instant fix.
Offshore driller Kosmos Energy, meanwhile, had a financial debt to equity ratio of nearly seven times at the end of the third quarter. That's a material amount of leverage to carry while oil prices are depressed. Callon Petroleum's situation is even worse, with a financial debt to equity ratio of 16 times. Add in their small sizes, and even higher oil prices aren't going to be enough to radically alter the balance sheet issues these two exploration and production names face. Meanwhile, the stock advances have priced in a lot of good news very quickly at all three of the companies here.
Now what
The real fly in the ointment here is time. Yes, the vaccine news is very positive. However, it will be months, if not whole quarters, before a vaccine is approved and disseminated widely enough to have a material impact on the trajectory of the coronavirus. And with COVID-19 cases spiking right now, there's a reasonable chance that oil demand remains weak for a while longer. Investors looking at the energy patch for bargains should tread carefully, sticking with large and financially-strong names, such as Chevron. Smaller fare, names with heavy debt loads, and those with company-specific issues are probably not worth the risk.
