Crude prices crumbled on Wednesday, closing more than 5% down to around $50 per barrel, after oil inventories jumped to a new record. Overall, crude stockpiles rose by 8.2 million barrels, according to the latest data from the U.S. Energy Information Administration, which was well above the analyst consensus for a 1.97 million-barrel increase. It was the ninth straight weekly increase in crude stockpiles and came even though OPEC and several non-member nations have reduced their output to drain the market’s oversupply. While most participating countries are following through with their pledges, rising shale supplies and falling demand from China are counteracting the impact of the output reduction.
That sell-off in the oil market weighed on financially challenged oil stocks, which will struggle if crude continues dropping. Among the biggest losers were Abraxas Petroleum (NASDAQ:AXAS), Whiting Petroleum (NYSE:WLL), Denbury Resources (NYSE:DNR), California Resources (NYSE:CRC), and Cobalt International Energy (NYSE:CIE).
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Most of these oil stocks have two things in common: weak balance sheets and higher cost production. As a result, they aren’t in a strong enough financial position to increase output to the same degree as their more active peers, many of which are projecting double-digit production increases this year as long as crude is over $50 a barrel. For example, Whiting Petroleum expects its production to average between 123,000 and 126,000 barrels of oil equivalent per day (BOE/d) in 2017, which is down from last year’s average of 129,890 BOE/d, in part because of recent asset sales, and even though capital spending will nearly double to $1.1 billion.
It’s a similar story at Denbury Resources. The enhanced-oil-recovery specialist will spend 44% more money this year on capex. However, despite that incremental capital, the company expects production to remain flat with 2016. California Resources, meanwhile, will run a flexible capital program this year depending on oil prices, with the hope to start growing production by the second half of the year if oil prices cooperate. But if oil prices continue dropping, these companies might need to slash spending, which could cause steep output drops this year.
Abraxas Petroleum is in a slightly different position. After struggling mightily over the past few years, the company sold non-core assets and equity to give it the cash to boost spending in 2017. As a result, the company plans to invest $110 million this year, up from a mere $31.7 million last year, which should push production from 6,181 BOE/d last year to as high as 8,600 BOE/d in 2017. However, that decision to accelerate activities in 2017 could come back to bite Abraxas if oil prices continue heading lower, because it’s outspending cash flow to deliver this growth, which isn’t sustainable, especially if oil were to keep dropping.
Finally, Cobalt International Energy is just trying to hold on as it scours the market for capital to finance its drilling program. The company had hoped to sell its Angolan assets to give it the cash it needs to keep drilling deepwater exploration and appraisal wells, but that deal fell through last year. As a result, the company had to complete an expensive debt exchange and financing transaction late last year, which bought it some more breathing room. However, with oil turning lower, it might become harder for the company to find a buyer for its Angolan assets, which is reigniting concerns that the company might run out of cash if it doesn’t find a solution soon.
There are two groups of oil stocks these days — those that can thrive at sub-$50 oil and those that can’t. Abraxas, Denbury, Whiting, California Resources, and Cobalt International are all in that latter category, which is why they were sinking so sharply today. Because of their situation, today’s drop is not a buying opportunity. Instead, investors should seek out producers that can thrive at lower oil prices, just in case crude does continue to head lower.