What: Shares of Colombian oil producer Pacific Rubiales Energy Corp (TSX:PRE) were up over 25% in early Tuesday trading.
The move can be largely credited to the rally in oil prices. Crude surged last Friday after a big drop in the reported number of rigs in operation. That rally carried over for a third straight day, sending the benchmark oil price over US$51 per barrel.
So what: During the boom years, Pacific Rubiales funded most of its expansion with debt. As such, the company’s solvency has come under question with the falling price of petroleum. In January, trading was temporary halted over rumors that Pacific Rubiales would default on its liabilities.
That’s why the reprieve in the price of oil is so welcomed. Since Friday, the price for West Texas Intermediate has surged 16%, one of the biggest three-day percentage increases for the U.S. oil benchmark. These prices take a bankruptcy at Pacific Rubiales off the table.
The question now is whether this rally is temporary or represents some sort of a bottom. Energy bulls believe that a big drop in supply could put a floor underneath prices. Oilfield services company Baker Hughes has reported large declines in the number of operating oil rigs for seven straight weeks. Since early October, the rig count has fallen 24% to just 1,223.
That figure is likely to drop further. Many forecasters have predicted the oil-directed rig count will fall below 1,000 by the end of the first quarter. Continental Resources, Inc, the largest driller in the North Dakota Bakken shale formation, has promised to cut the number of rigs it employs by 40% in 2015. If you were to extrapolate those cuts across the entire shale industry, the rig count would average just 950 in 2015 as a whole. That could put a firm bottom underneath prices.
That said, there’s good reason to believe the current rally is just a temporary event. According to records published by the U.S. Commodity Futures Trading Commission, hedge fund bets against WTI are now the highest since November 2010. In the event of unexpected good news like the kind we saw last week, these large short positions can temporary send markets soaring higher on a wave of panic buying.
Now what: Pacific Rubiales needs sustained higher oil prices to fund both distributions and meet its debt obligations. While the company can cut its payout and capital spending to conserve cash, investors still have to worry about its heavy debt load. That means this stock will be volatile regardless of which direction oil prices go.
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Fool contributor Robert Baillieul has no position in any stocks mentioned.