TTP – Oil and gas sector commentary

Global oil prices have crashed after Saudi Arabia announced a price war to claw back market share that the kingdom feels it has lost in recent years.

The focus of this price war is ostensibly Russia, with whom Saudi had been in a shaky alliance to support global prices until very recently. However, the collapse of this entente has now sent shockwaves throughout the oil sector far beyond Russia as the high-cost US shale producers will take a major hit. Not only this, most other OPEC members lack the capacity to turn the taps on like Saudi and crucial offshore production regions such as the Gulf of Mexico and the North Sea will struggle badly if this continues.

Coupled with a sharp reduction in global oil demand and Chinese demand, in particular, driven by the spread of the coronavirus and efforts to contain it, we appear to have hit a crunch with many of the hallmarks of the global financial crisis in 2008/09.

However, it may not all bad news for investors looking for value in the oil and gas sector. In this regard, we would look more carefully at the smaller companies orientated to the exploration, development and production of gas, the price of which is largely delinked from crude oil and often based on fixed-price contracts and more localised markets.

Long seen as a ‘transitional’ hydrocarbon as developed countries attempt to reduce their reliance on coal and oil, several AIM minnows are focused entirely on gas and gas prone regions of the world.

Examples of such include Cluff Natural Resources, Coro Energy, SDX Energy, Prospex Oil & Gas, Sound Energy and Wentworth Resources to name but a few*. A quick examination of the asset portfolios of a range AIM sector E&Ps will reveal a significant sub-sector of companies hit badly by the sector fallout but with proportionately less in the way of actual exposure to $30 oil prices.

Cash is king in the oil sector and yes, there is still a raft of underfunded E&P companies where life just got even tougher in light of crumbling sentiment. However, we would recommend that investors examine companies with decent asset portfolios but no major commitments in 2020.

The ability to sit this downturn out could easily provide upside to more patient or risk-averse investors. If you are looking for a more aggressive strategy, look at recently funded companies with firm drilling plans targeting gas in particular. They do exist in the form of Predator Oil & Gas and SDX Energy targeting gas in Morocco or Union Jack full funded to participate in the upcoming onshore UK West Newton well test for example*

With the sector on its knees, this is a buyers’ market for explorers with cash. Rigs and crews could be lying idle for months now and day rates will fall to keep the service companies ticking over. As such, look for companies with fully funded drilling plans over 2020 as the sector downturn will enable them to get more bang for their buck.

In summary, there is no doubt that the sector is in freefall and the upturn can’t be called yet. However, there may be money to be made if investors look at the fundamentals of an individual company. This downturn will sort the wheat from the chaff and there will be more losers than winners but the gas-focused companies with decent management, robust balance sheets and little in the way of unfunded commitments may well be able to see this out.

*Note that these are examples of predominantly gas-focused companies and this discourse does not constitute a recommendation to buy or sell shares in these companies

Published 10th March 2020

Copyright © 2020 Turner Pope Investments (TPI) Limited, all rights reserved.


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