Nearly all markets have been taking a tumble in recent months, but oil prices in particular have been taking a heavy hit. The most widely followed commodity has entered into a technical bear market, falling over 20% to $60, down from a multi-year high of $86.
While falling oil prices can be triggered by weaker global demand for energy, Martijn Rats, Morgan Stanley’s Global Oil Strategist, does not expect this to be the case.
He expects oil prices to rebound near the end of the year, lifting energy related stocks and bonds, urging investors to resist selling and instead “opportunistically add to their holdings in energy stocks”.
Companies heavily involved in hydrocarbons are highly correlated to oil prices, and have not been spared during the past several weeks of sell offs. However, negative investor sentiment, which is often prone to wild swings, may have made energy stocks more attractively valued - if they have good cash flows, healthy dividends, and sound corporate strategy.
Martijn, noted that lower oil prices were mainly a result of surges in supply; citing favorable weather conditions causing U.S. fracking output being stronger than expected, and sanctions on Iranian oil exports being lifted at roughly the same time Saudi Arabia increased oil production. He expects these conditions are likely to shift in the coming months.
Jeffrey Currie, global head of commodities research at Goldman Sachs, believes momentum triggered a “negative gamma event”, forcing a lot of oil producer hedging programs to drive prices even lower. However he believes the fundamental story “just doesn’t justify it”, and that the underlying fiscal situation of OPEC producers can’t sustain prices going any lower, and therefore expects them to curb production.
When the market moves towards a downturn, a generally accepted capital preservation strategy is to be overweight defensive stocks, such as commodities and consumer staples. The market sell off has driven stocks to fall across the board, with blue chips such as amazon, apple and others falling 20% or more, however, energy companies have fallen less dramatically.
Warren buffet, the notoriously famous value investor, takes the approach of buying stocks that have fallen in price but not in value.
This is what some UK energy companies are doing-
Royal Dutch Shell (RDSA) a “supermajor” has been continuing a share buyback programme that began in July this year, starting the second tranche at the start of November. The company intends to buy back “at least $25 billion” worth of shares by 2020. The company reported $14.7 billion in cash flow from operations in Q3 2018, and maintains a strong cash flow outlook.
British Petroleum (BP) another oil major reported $6.6 billion in operating cash flow in Q3 2018, (excluding Gulf of Mexico oil spill payments). It delivered 5 major projects in 2018, with two projects in 2019 under budget and ahead of schedule. It underscored that its focus on safe and reliable operations are continuing to drive growing cash flow and strong earnings.
Hurricane Energy (HUR) is an independent oil company lead by maverick geologist Dr. Robert Trice. Experts believe it could be the biggest discovery in British waters for a decade, with estimates suggesting there could be billions of barrels of crude ready to drill under the ocean floor near the Shetland islands. Well financed, with Morgan Stanley as joint corporate broker, and its floating production, storage and offloading vessel having set sail for the field with plans for first oil in H1 2019, markets will be watching this company development closely.
Union Jack Oil (UJO) a closely followed AIM listed company, with a focus on diversifying its assets across exploration, appraisal & production of oil and gas. With £5m in cash for operations, lead by a veteran management team with decades of industry experience, the strategy is to cherry-pick deals and take 10-20% stakes in the licenses, reducing risk but retaining exposure to successful high impact drills.
I3 Energy (I3E) a North Sea focused AIM listed company, is currently undertaking a farmout process of its 100% owned North Sea Assets. The licenses hold 237 million barrels of oil according to an audited mid case STOIIP (stock tank oil-initially-in-place), it’s own estimates projecting 314 million. With sufficient cash resources and funding, it expects to conclude the field development plan approval in H1 2019.
SDX Energy (SDX) focused on Egyptian oil and gas assets, has been delivering impressive revenues from its wells in Egypt, generating $3.5m of cash per month with no debt. The company recently made headlines after confirming it was in talks with BP to acquire a significant package of assets in Egypt, estimated to be worth around £380m, which ultimately fell through by mutual agreement.
Reabold Resources (RBD) the low-cost non-operator AIM listed company, is pursuing a strategy of focusing on finding undervalued, low-risk, near-term upstream oil & gas projects with a clear exit plan. Several high-impact projects expect to be drilled soon, including its stake in Corallian (Wick and Colter licenses), California (Monroe Swell and West Brentwood licenses), Rathlin (West Newton A-1 gas discovery), and Danube’s Parta license.
United Oil & Gas (UOG) another independent oil and gas startup, lead by a former Tullow Oil executive team, is also involved in the Colter well, as well as gas discoveries in Italy, and two prospective blocks in the North Sea. The strategy is to buy unwanted oil and gas licences and find untapped value in smaller fields that larger companies ignore.
Block Energy (BLOE) is an AIM listed company focused on Romania, with three licenses in the heart of the prolific Kura basin, with proven oil reserves of 1.5 million barrels, and contingent resources of 60 million barrels. It intends to use short term cash flow to drill horizontal wells and sidetracks to eventually raise production to c. 2000 barrels of oil per day. Global interest into the country is growing, with ExxonMobil recently entering to carry out a comprehensive review of the country’s hydrocarbon resource base for the Government of Georgia.
Upland Resources (UPL) is another indendent oil and gas company with interest in Licence P2235, which contains the highly anticipated Wick prospect. Upland estimates the licence could hold up to 250 million barrels of oil, (P50 estimates). It is also exploring and developing interests in licences located in North Lincolnshire and Sarawak, Malaysia.