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Why Oil Stocks Are Going Ballistic Today

What happened

Oil prices are in rally mode today. WTI, the main U.S. oil price benchmark, was up 4.5% to about $39 a barrel by 10:15 a.m. EDT on Friday. Meanwhile, Brent, the global benchmark, surged 5.3% to above $42 a barrel. Fueling the rebound in crude prices was a report that OPEC and its partners had agreed to extend their historic production cut by another two months. On top of that, the U.S. government reported a stronger-than-expected jobs report in May, suggesting that demand for gasoline will continue to accelerate as more people return to work.

Surging crude prices fueled a ferocious rally in oil stocks. Shares of Callon Petroleum (NYSE: CPE) and QEP Resources (NYSE: QEP) zoomed more than 35% in early-morning trading. Meanwhile, others like Marathon Oil (NYSE: MRO), Occidental Petroleum (NYSE: OXY), Apache (NYSE: APA), and Continental Resources (NYSE: CLR) all rallied by at least 10%.

Image source: Getty Images.

So what

Bloomberg reported that OPEC and its partners have tentatively agreed to extend their initial production curtailments for another two months. The group planned to curb its combined output by 9.7 million barrels per day (BPD) in May, the reduction to taper off to 8 million BPD through the end of this year. However, it now plans to maintain the reduction of 9.7 million BPD through the end of July. That will provide the global economy with more time to recover and burn off excess inventory.

OPEC's decision supports the view that oil prices will continue rebounding, which would benefit U.S. producers, especially financially weaker ones. That certainly describes Callon Petroleum and QEP Resources. Callon's credit profile is so concerning that it's a prime bankruptcy candidate. Meanwhile, QEP Resources' financial situation was so bad that it recently had to amend its credit facility so that it had the liquidity to keep operating.

The earlier weakness in oil prices also forced Marathon, Occidental, Apache, and Continental to shore up their finances. For example, both Marathon and Continental suspended their dividends and slashed capital spending. Meanwhile, Occidental cut its dividend twice -- reducing it 98.7% overall -- and Apache slashed its payout by 90%. Both also gutted their capital spending plans.

However, with oil prices rebounding, these companies should generate more cash flow in the coming months. One of the biggest beneficiaries of this rebound will be Continental Resources. The company shut in 70% of its production in May because of low oil prices. It can now turn those pumps back on and capture higher pricing in the coming months.

Occidental Petroleum will be another major beneficiary of improving oil prices. The company has a mountain of upcoming debt maturities it needs to address. With oil rising, it's more likely that Occidental will be able to sell assets at a higher value and refinance some debt.

Now what

With OPEC expected to provide further support for the oil market -- and the jobs market unexpectedly rebounding -- investors are gaining confidence that the worst is in the rearview mirror. Because of that, oil prices should continue improving, which will boost U.S. producers' cash flows. That would be a huge relief to financially weaker producers, which have cut spending to the bone to survive this downturn. Now they appear poised to cash in on a continued rebound in crude oil.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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