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Why Oil Stocks Are Rocketing Today

Matthew DiLallo, The Motley Fool

What happened

The price of crude oil climbed to its highest level in nearly three-and-a-half years today, with the U.S. oil benchmark price rising 3% by the mid-afternoon to roughly $68.50 a barrel. Two factors fueled today's gains. First, a closely watched U.S. government report showed an unexpectedly bigger drop in oil storage levels, indicating once again that OPEC's plan to drain off the market's excess is working. In addition to that, Reuters reported that Saudi Arabia wants to get crude back up to between $80 and $100 a barrel so that it has the cash to complete some much-needed economic reforms and pay for a war with Yemen.

That bullish inventory number, along with the potential for even higher oil prices, sent oil stocks soaring, with several smaller producers spiking more than 10% today. Among that group was EP Energy (NYSE: EPE), Sanchez Energy (NYSE: SN), Denbury Resources (NYSE: DNR), HighPoint Resources (NYSE: HPR), and Carrizo Oil & Gas (NASDAQ: CRZO).

The silhouettes of oil pumps with a red sky in the background.

Image source: Getty Images.

So what

The only fuel driving these oil stocks higher was the price of crude, which is crucial to their businesses. EP Energy enjoyed the biggest rally, popping more than 20% on the day. The company has struggled in the aftermath of the oil market downturn, which forced it to restructure operations and sell assets. However, even with that progress, the company noted last quarter that it's still driving toward cash flow neutrality and reducing leverage further. Both aims become easier to do as oil prices rise, which is why EP Energy's stock is taking flight on today's bullish bounce.

Those same factors are behind today's double-digit moves in Sanchez Energy and Denbury Resources. Both oil stocks need to pay down debt, which has weighed them down the past few years. With oil approaching $70 a barrel, these two oil producers could generate much more cash flow than expected this year, which would enable them to pay down debt faster.

HighPoint Resources, on the other hand, is coming off a game-changing merger that will provide the company with accelerated growth prospects and a much-improved balance sheet. While the companies combined so they could prosper at lower oil prices, that deal will enable HighPoint to thrive now that oil is nearing $70 a barrel.

Carrizo Oil & Gas, meanwhile, recently caught the eye of an activist hedge fund that's pushing the company to make changes in light of its significant underperformance over the past year. Among the actions the investor wants the company to take is either selling off assets and using that cash to pay down debt, buy back stock, and reinvest in what remains or put the whole company up for sale. With crude heading higher, its assets are growing more valuable, potentially making either option an even more lucrative one for Carrizo to consider.

Now what

Smaller oil producers tend to rise to a much greater extent when crude makes a big move, which is what we're seeing with these oil stocks today. They also tend to plunge if it takes a tumble, which is always a possibility. That's why investors might want to avoid the potential of getting burned by these red-hot oil stocks and instead consider some that are still screaming bargains.

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