Best Oil Stocks for the High-Risk Investor

By Markets Fool.com

Oil prices can be absolutely crazy. Just the thought that supply and demand is going out of balance can send oil prices on a roller coaster ride that can make even the most seasoned investor sea sick. The uncertainty over where oil prices will go next can have an utterly disastrous impact on the stock prices of riskier oil companies. As we see in the chart below, the more than 50% plunge in oil prices sent risker oil stocks like Halcon Resources Corp. and SandRidge Energy down more than 75% from their 52-week highs.

Continue Reading Below

HK Chart

HK data by YCharts.

While plunging oil prices can blow up the stock prices of risker oil names, the opposite happens when oil prices rebound. With single-digit stock prices, both companies could double or more in 2015 if oil prices enjoy a rapid rebound. Here is a look at why both stocks are so beaten down right now, and why history could repeat itself if oil prices rebound.

Risk has a name
The biggest risk facing both SandRidge Energy and Halcon Resources is the debt on their balance sheets. As we see in the following chart, the debt levels of both companies have been on the rise over the past few years as both outspenttheir cash flow to drill oil wells.

SD Net Total Long Term Debt (Quarterly) Chart

Continue Reading Below

SD Net Total Long Term Debt (Quarterly) data by YCharts.

While SandRidge Energy's debt has fallen on occasion as it sold assets and reset its debt level, the fact remains that the company still has a large and growing debt load. Meanwhile, Halcon Resources' debt level has not stopped rising as the company has continued to pile on more debt with each well it drills.

The plunge in oil prices really puts both companies in a bind. While both hedge oil production to protect against falling oil prices, those hedges don't last forever. Meanwhile, in SandRidge Energy's case, it uses a lot of 3-way collars to hedge, which don't work quite as well when oil prices really plunge. Because of this, the cash flow of both companies is expected to weaken considerably over the next year if oil prices don't improve.

This spells double trouble, as not only will these companies have less cash flow to reinvest in new wells, but they'll have less cash flow to meet debt obligations. It's this second risk that has investors gravely worried, as the fear is that either company could face a liquidity crisis and be forced to declare bankruptcy if low oil prices persist for a couple of years.

Big drops can lead to big bounce backs
All that being said, if oil prices do improve dramatically in 2015, then this bankruptcy worry will fade away. Once it does, the stock prices of both companies could skyrocket. For example, the last time oil prices corrected was during the financial crisis in 2008. That crash also decimated the stock prices of both the predecessor company to Halcon Resources and SandRidge Energy, as we see here:

SD Chart

SD data by YCharts.

That chart shows that oil prices plunged 69% from the peak, which took the stocks of SandRidge Energy and Halcon Resources' predecessor company down by more than 85% from their 52-week high that year. However, when oil prices rebounded over the next year as the panic subsided, so did the stock prices of both companies, as we see on this next chart:

SD Chart

SD data by YCharts.

That chart shows that oil prices bounced back nearly 72% in 2009. That surge in the price of oil led Halcon Resources' predecessor company's stock price to double by the end of the year while SandRidge Energy's stock price doubled by October before settling up just over 41%.

Investor takeaway
History does tend to repeat itself, though it's always possible that this time things will be different, and that this time, both companies will go bankrupt before oil prices rebound -- if they rebound at all. That being said, investors looking for a binary outcome of either a double or a zero should take a closer look at these two oil stocks, because either outcome is possible by the end of 2015.

The article Best Oil Stocks for the High-Risk Investor originally appeared on Fool.com.

Matt DiLallo owns shares of SandRidge Energy. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.