What happened
Crude oil prices are tumbling today. At 10:30 a.m. EDT on Tuesday, WTI (the U.S. oil price benchmark) was down 7.6% to $36.75 a barrel, while Brent (the global benchmark) fell more than 5% to below $40 a barrel. Weighing on pricing was tepid demand, which led Saudi Arabia to slash the price at which it sells its oil.
That sell-off weighed on most oil stocks. Several tumbled by more than 10%, including Transocean (RIG -2.91%), Kosmos Energy (KOS -4.74%), and QEP Resources (QEP).
Image source: Getty Images.
So what
Saudi Arabia reduced its official selling price for oil exported to Asia by the most since May and cut its price to U.S. customers by the most in six months. It made that move because of weakening demand as COVID-19 cases surge in places like Europe and India causing more people to stay home to help slow the spread. Meanwhile, market forecasters expect demand in the U.S. to hit the brakes due to the end of the summer driving season.
Making matters worse, oil companies in the U.S. appear to be ramping up their drilling activities, implying a future rise in supplies at a time when demand is cooling off. Drillers have added rigs in two of the last three weeks while also stockpiling drilling permits ahead of the upcoming election on fears that a potential Biden administration would ban fracking on federal land.
With demand slowing and supplies likely rising, it's putting renewed pressure on financially weak oil companies. This year's sell-off has hit the offshore drilling market particularly hard. Several companies have filed for bankruptcy this year, causing concern that Transocean might be next. The company has a boatload of debt maturing in the coming years, some of which it's trying to restructure via a debt exchange. If it can't address its debt, which is more likely if oil prices keep falling, it might have no other choice but to file for bankruptcy.
Meanwhile, offshore-focused oil producer Kosmos Energy is in a similar boat. The company needs oil to remain above $35 a barrel to generate free cash flow during the second half of the year so that it can chip away at its debt. With oil getting dangerously close to that level, investors are getting worried that it will start tacking on more debt again, which would add more weight to its stock.
QEP Resources is also facing a financial crunch because of lower oil prices. Though, on a positive note, the company recently received a $170.7 million tax refund, which will enable it to repay some bonds that mature next March. However, that's a fraction of the nearly $1.9 billion it owes creditors, with most of that coming due over the next three years. It had hoped to chip away at that number by generating free cash, but that will be harder to do if oil prices fall too much further.
Now what
With oil taking another tumble, it's causing renewed concern about the survivability of financially weaker companies. If crude keeps sinking, it could cause even more companies to file for bankruptcy. Because of that, investors should steer clear of financially troubled oil companies, given the increased likelihood that their stocks could go all the way to zero if market conditions get much worse.
