Another week, another whoa. Baker Hughes' (BHI) just-released rig count data show the overall number of rigs in action in the U.S fell 14 to 795 last week, and the most analyzed figure -- U.S. land-based oil-seeking rigs -- also showed a strong decline, down nine to 605.
Front-month (November) futures for WTI crude jumped above $50 a barrel after the data were released. I think the market is finally understanding the calculus: Fewer rigs in action mean less production in coming months, and the perceived oversupply that drove crude's massive plunge really isn't there anymore.
I remain bullish on oil prices, and expect to see a move through $60 a barrel for WTI crude by year-end.
The hot topic among small- and micro-cap E&Ps is now debt exchange. In the last few days, both Goodrich Petroleum (GDP) and SandRidge Energy (SD) have announced the consummation of exchange transactions.
The companies are buying back some notes at low ratios vs. face value -- 50% in GDP's case, 30% in SD's case -- and offering new convertible securities that have much lower conversion prices in common. (SandRidge Energy is part of TheStreet's Stocks Under $10 portfolio.)
So that's how companies are buying themselves time, and bondholders are happy to take a fraction on the dollar. Many of these bonds have been left for dead, and I believe some smart funds purchased them at much lower levels, while long-term holders get the liquidity.
All this is taking place against the backdrop of the redetermination cycle. Essentially, energy company reserve-based revolving credit facilities are recalibrated twice a year, as the banks look to peg the value of the facility to the updated value of reserves. Obviously, lower prices lead to lower reserve values, other things equal.
Banks are under pressure from the Office of the Comptroller of the Currency (OCC) to rein in exposure to oil and gas borrowers. The OCC has deemed energy a "risky" sector for lending. Thanks, OCC! Never would have figured that one out! What would we do without those sharp-eyed bureaucrats in D.C.?
But a funny thing happened on the way to Armageddon. E&P managements actually knew of the redetermination cycle and many have taken proactive steps to lessen the impact. Goodrich, for instance, used proceeds from a sale of assets in the Eagle Ford shale to completely pay down its revolver balance. When a company has zero drawn, the amount available on the revolver is basically irrelevant.
So add "redetermination devastation" to the list of bogeymen that have failed to knock out these gritty, resourceful little E&Ps. All year we've been hearing predictions of the demise of the smaller E&Ps, but they have not come true:
-- Cushing's going to fill up and knock oil prices to $35 a barrel. Didn't happen.
-- Saudi Arabia's going to push the limit on domestic production and cause oil prices to drop to $30 a barrel. Nope.
-- Chinese demand is going down the drain and will drive oil prices to $20 a barrel. Platt's most recent data show that Chinese apparent oil demand rose 10.2% in August. Wrong again!
That's why I am still trading in and out of these stocks: The short arguments are specious and often factually untrue. Nobody wins with oil at $50 a barrel, but the chances of losing -- i.e., bankruptcy -- are in fact lower than they were at $40 a barrel, and only some in the market seem to have figured that out.
My favorite in the sector remains Magnum Hunter Resources (MHR), and other than Goodrich and SandRidge, other intriguing E&P micros include Victory Energy (VYEY), Torchlight Energy (TRCH) and Evolution Petroleum (EPM).
