What happened

Oil stocks across the board are flying higher today thanks to the sharp reversal in oil prices, but small-cap stocks are shining the brightest, with Centennial Resource Development (PR -0.58%) and Core Laboratories (CLB) leading from the front. Soaring gas prices are also sending stocks of  coal producer Peabody Energy (BTU -3.40%)higher. Here's how the stocks are faring as of 2:10 p.m. EDT:

  • Centennial Resource: up 9.4%.
  • Core Labs: up 8.7%.
  • Peabody Energy: up 10%.

So what

The double-digit price tumble in shares of Centennial Resource and Core Labs last week has presented investors in oil and gas stocks with the perfect opportunity to scoop up some shares today.

Crude oil prices are reversing today after a week-long decline and are up more than 5% this morning. Profitability for upstream oil and gas stocks depends entirely on oil prices, which explains today's surge in Centennial Resource shares. To give you an example, Centennial Resource's revenue jumped more than twofold in its last quarter despite lower production thanks to significantly higher average realized oil prices.

Core Labs shares are rallying higher as well in anticipation of a steady oil environment possibly fueling larger capital investments by oil and gas producers, and consequently bumping up demand for the products of this oilfield services company.

There is some merit in the optimism.

The weekly rig count in the U.S. went up by three to 503 as of Aug. 20, as per data from one of the world's largest oilfield services company, Baker Hughes. Rig count is a key barometer for the oilfield services industry as the greater the number of active rigs, the higher the demand for products and services used to improve oil recovery and production. At a recent industry conference, management at oilfield services industry leader Schlumberger (SLB 0.44%) even predicted an "exceptional growth cycle" for oil and gas business based on estimates of demand for oil hitting pre-2019 levels by the end of next year amid tight supply.

A person raising his arms in celebration while looking at stock price charts on a computer screen.

Image source: Getty Images.

Tight supply is, indeed, a valid reasoning, at least for now. Drilling activity is rising at a slow pace as most oil and gas producers are keeping production tight and operating fewer rigs in a bid to maximize asset efficiency while keeping costs low. Limited focus on production and greater focus on cash flows and balance sheet, in fact, have been the biggest themes during this oil market boom.

Centennial Resource too, for example, generated record free cash flows (FCF) in its last quarter that it primarily used to repay debt. The company reiterated its intention to stick to a two-rig drilling program as it continues to prioritize FCF. To give you an idea about the kind of money the company is making from higher oil prices, management recently upgraded its full-year FCF estimate to a range of $140 million to $170 million from its earlier projection of $65 million. Not surprisingly, the rally in oil prices today has got investors excited.

Natural gas prices have also shot up in recent months and are up roughly 2% today. While that's been a boon for natural gas companies, higher prices have also, ironically, boosted the prospects for coal producers like Peabody Energy. Demand for electricity has shot up as economies across the globe reopened after COVID-19 pandemic lockdowns. With gas prices also rising, utilities have been forced to fall back on coal to generate enough power to meet demand.

Coal prices have more than doubled this year, and coal inventories in China -- the world's largest coal consumer -- are depleting rapidly. It's the perfect setting for Peabody Energy to make more money.

Now what

Given last quarter's strong performances from Centennial Resource and Core Labs, it was surprising to see their stocks tumble after earnings. The market clearly read too much into headline numbers and ignored the real ones that confirmed these oil companies are doing exactly what they should in the present business environment: strengthening their balance sheets. The same holds equally true for Peabody Energy, which lowered its debt by 12% through the first half of 2021.

As long as oil and gas prices can maintain momentum, investor interest in these stocks will remain high. I also wouldn't be surprised to see analysts jumping in to upgrade their views on these stocks. Investors, though, should always take a long-term view before putting their hard-earned money to work and bet on stocks primed to grow shareholder returns manifold.