Crude oil's longest winning streak in 10 months came to an abrupt halt this week after Russia said it wouldn't consider making deeper cuts in its output to help prop up oil prices. That refusal, when combined with government data showing that U.S. production rose another 88,000 barrels a day last week, sent oil down more than 4% on the week and below $45 per barrel.
That decline in the price of oil hit weaker drillers hard. Several plunged double digits on the week, led by California Resources (NYSE: CRC), Sanchez Energy (NYSE: SN), Obsidian Energy (NYSE: OBE), and QEP Resources (NYSE: QEP), according to data from S&P Market Intelligence.
California Resources led the way lower, plunging nearly 25% over the past week. Driving the selling is the fact that California Resources needs oil to be much higher to survive, let alone thrive. Despite making progress in shoring up its balance sheet over the past year, the company has a significant debt problem. According to its estimates, its debt-to-EBITDAX ratio will be more than 7.0 this year, and that's assuming crude averages $55 per barrel. Furthermore, California Resources expects to spend more than half its cash flow on interest expenses this year, leaving it with little left over to finance capital investments that would maintain and grow output. While the company doesn't have any near-term debt maturities, it needs oil to rally significantly in the coming years so it can stay afloat.
Sanchez Energy also fell sharply, ending the week down more than 15%. Weighing on the stock is the fact that the Eagle Ford Shale-focused driller also has too much debt for current crude prices. The company's plan was to grow into its balance sheet by expanding output more than 20% per year, which would drive its leverage ratio below 3.0 next year. However, there are a couple of problems with that plan. First, Sanchez Energy based its budget on crude averaging $55 per barrel. Furthermore, a 3.0 leverage ratio is still well above the industry average of 2.0 times debt to EBITDA. Given where crude is these days, Sanchez Energy needs to slow its drilling pace and pay down debt so it doesn't get crushed if oil stays lower for longer.
Obsidian Energy, formerly Penn West Petroleum, also fell double digits this week due to lower oil prices. While the company does have a stronger balance sheet thanks to its decision to sell a slew of assets last year, it's not in the position where it can thrive at current prices. For example, it expects to deliver double-digit production growth this year while living within cash flow at $40 oil. However, Obsidian Energy can't sustain that rate over the long term since it can only increase output by 3% annually starting next year, and that's assuming it spent all the cash flow it generates at $50 oil. Given that some analysts see oil heading much lower in 2018, Obsidian could struggle to maintain output in the future.
QEP Resources is also falling under the weight of lower oil because it can't support its ambitious growth plan at current prices. For 2017, QEP Resources intends on spending up to $1 billion drilling and completing new wells, primarily in the Permian Basin, which would drive its oil output up 6% compared to last year. However, it's burning through cash to finance that plan, using more than $100 million of its cash balance in the first quarter alone. If QEP Resources keeps it up, it'll be out of cash by the end of the year, which would require the company to start tapping its credit facility and add more debt to an already stretched balance sheet. That's something investors don't want to see it doing in an environment where oil is falling as a result of too much supply.
The longer crude oil stays below the mid-$50-a-barrel range that most drillers expected, the more likely that weaker producers will need to start cutting back on spending. If they don't, these companies run the risk of piling on more debt to pump out oil that the market doesn't need, which could have disastrous consequences down the road. Given that tight situation, investors should steer clear of oil companies with high debt levels and the inability to finance growth within cash flow at lower oil prices, because their stocks could still have more downside if oil doesn't improve.
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