A ski jumper who leans too far forward when they jump gets “ahead of their skis” and can wind up taking a nasty fall instead of making a long, clean jump. The same can be said in the oil patch, where investors in oil stocks may be anticipating big gains from small frackers based on scant evidence.
It’s true that oil is on a bull run. Prices for West Texas Intermediate crude, the U.S. standard, have more than doubled from their lows of last February. At oil’s current price of roughly $55 per barrel, it is possible that some oil stocks could be profitable in 2017 after suffering financial disasters over the last two years.
But many fracking companies in once-popular plays like Ohio’s Utica Shake, Oklahoma’s Anadarko Basin and especially the Eagle Ford play in South Texas are seeing exploding stock prices — even before financial gushers come in.
Take Sanchez Energy. Please.
One example is Sanchez Energy Corp (NYSE:SN), which focuses on the Eagle Ford, a sweep of old oil land running in an arc from Mexico and Laredo in South Texas all the way up to Dallas. The stock, which has a current market cap just short of $600 million, has more than doubled in value over the last year, to over $9 per share, even while it has struggled financially.
During the first three quarters of 2015 Sanchez accumulated losses of over $300 million, a whopping $5.60 per share, on revenue of about $310 million. The trend is positive. Operating expenses were cut from over $600 million during the September 2015 quarter to under $170 million for the most recent period. Operating cash flow has remained positive.
But the company’s efforts to pay back debt have run up against a fall in asset values. The debt-to-assets ratio at the end of last September was still 150%. No new long-term debt was taken on, but the value of the company’s assets fell by 20%.
I have a rooting interest here. My wife’s family leased some land to SN early in the decade, and the cash helped my kids get out of college debt-free. I even have a Sanchez hat. But unless the company’s results can blow past estimates — most expect losses to continue through the year — it’s hard for me to make a financial case for the stock.
Dead Men Drilling
Sanchez is not the only oil exploration company carrying a balance sheet uglier than the Cleveland Browns’ offensive line.
Carrizo Oil & Gas Inc (NASDAQ:CRZO) had assets of $2.32 billion at the end of September 2015, and just $1.42 billion a year later, meaning an $80 million cut in long-term debt still left it nearly fully indebted by the end of last September. Yet the stock rose 26% during 2016, and opened for trade on Jan. 3 at $37.35.
Chesapeake Energy Corporation (NYSE:CHK) saw its asset base cut nearly in half between September 2015 and September 2016, from $21.29 billion to $12.52 billion. The debt load was also cut, from $10.67 billion to $9.022 billion. But the debt-to-assets ratio still rose, the company lost $1.155 billion, or $1.54 per share, during the most recent quarter and the stock price over the last year is up 56%.
The steeper the fall among the drillers, the steeper the rise, even for those drillers that remain far from earning a profit. Of the 16 analysts following Sanchez six now have it rated as a buy. Most Carrizo analysts are telling investors to buy, buy, buy that stock. And and five out of 26 Chesapeake analysts have it rated as a buy, with three having moved off their sell recommendations in the past three months.
Bottom Line on Oil Stocks
A lot of U.S. shale players are being saved by OPEC pushing down production and pushing up prices. But many of these companies continue to need financial intensive care. Many have commitments to sell production at prices at less than the current market price going out for years. They are not as highly leveraged to rising prices as investors may think.
Personally, I would much rather have an oil stock that breaks even right now, like Pioneer Natural Resources (NYSE:PXD) or EOG Resources Inc (NYSE:EOG), than speculate on companies that were “dead men drilling” during 2016. If you’re plunging into the oilpatch, plunge carefully.
Dana Blankenhorn is a financial and technology journalist. His latest novel is Bridget O’Flynn vs. Something Big & Ugly. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing, he did not hold a position in any of the aforementioned securities.
