Shares of energy company Antero Resources (NYSE:AR) rose roughly 12% within the first hour of trading on Jan. 5. That’s a pretty impressive jump out of the gate, but it was easily beaten by the 14% gain at Kosmos Energy (NYSE:KOS). And that, in turn, was outdone by the slightly over 15% advance that SM Energy (NYSE:SM) achieved. There wasn’t any material news out of any of these exploration and production companies, but that doesn’t mean there was no news to consider.
Antero, Kosmos, and SM Energy all share one important trait: Their top and bottom lines fluctuate with the ups and downs of the commodities they produce. And, on that score, oil and natural gas saw notable gains in early trading today. Although the stock gains are, in some ways, as simple as that to understand, there’s more to the story in the energy patch that investors need to know.
Last year was terrible for oil and natural gas. The market entered 2020 with a slight oversupply thanks to a decade or more of growth in production from the onshore U.S. market. OPEC had been trying to offset the increases with output cuts, but it wasn’t doing much good. Prices weren’t particularly strong. Then, early in the year, OPEC and Russia got into a spat over the cuts and opened up the spigots, adding oil to the market. At around the same time, the coronavirus pandemic started to spread, leading countries to effectively shut their economies, severely curtailing demand. Oil prices plummeted as supply swamped demand, with key U.S. oil benchmark West Texas Intermediate actually falling below zero for a brief moment in time. OPEC and Russia made up, cutting output again, but the damage was done, including a massive buildup of oil in storage.
Since that nadir, demand for oil and gas has started to return, though it is still well off of its normal level. But the demand increase and ongoing curtailments from OPEC have been enough to stabilize oil and natural gas prices. Which brings the story to today. At the end of 2020, OPEC and Russia were again discussing production increases. This time, however, they have generally agreed to take a more nuanced approach, with slow and steady hikes throughout 2021 — and regular monitoring to ensure that supply doesn’t outstrip demand again.
A monthly meeting started yesterday, Jan. 4, with little to show for it. However, as today’s continuation of the meeting got underway, it looked as if OPEC and Russia were coming to the agreement that production would be held steady in February. The reason for that apparent decision is the recent uptick in coronavirus cases seen around the world. Indeed, with countries starting to talk about or even institute renewed lockdowns (the United Kingdom just announced such a plan), being cautious is looking increasingly like the right path forward to everyone involved — at least for now.
Energy traders appear to have taken the still unofficial OPEC news as a positive and bid up oil and natural gas prices. And that in turn led investors to bid up the shares of Antero, Kosmos, and SM Energy. This isn’t particularly shocking given that all three have heavy debt loads, which means higher energy prices will be particularly helpful as they look to muddle through the industry’s deep downturn. To put numbers on that, SM Energy’s financial debt-to-equity ratio is a lofty 12.9 times, followed by Kosmos at roughly 6 times, and a more modest 3 times for Antero.
That said, Antero recently announced the completion of a refinancing effort, in which it sold $500 million of 8.375% notes due in 2026 so it could buy back a portion of the debt it has coming due in 2022. However, it’s worth noting that the debt being bought back carries an interest rate of 5.125%. The difference in the rates here is evidence of the increased concern investors have about the prospects for the energy sector and, more specifically, Antero’s balance sheet.
It wouldn’t be appropriate to say that the early gains in the shares of Antero, Kosmos, and SM Energy are much ado about nothing. OPEC’s production does matter a lot right now, as it is playing an important role in the effort to balance supply and demand. And the success or failure of that effort will have a material impact on energy companies across the board. Unfortunately, uncertainty remains very high in what is already a historically volatile sector. Most investors would probably be better off avoiding leveraged names like these and focusing on the largest and strongest players in the energy patch, such as international major Chevron.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
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