Tom Law: Oil & Gas Sector Leader 2015-16

Market Report

It is no secret that the oil and gas market is extremely volatile at the moment. Following the drop in price of crude oil to below $30 a barrel, many related firms have taken a significant hit to their share prices. We advise to steer clear of purely upstream firms – that is firms that are involved solely in the extraction of crude – as these firms are most exposed to the price of oil.

With most analysts forecasting a higher long-term oil price, we feel the market is urging this increase, maybe prematurely, in order to realise the potential upside profits. However, concerns over China’s economy and a Federal Reserve rate hike following the upcoming US employment report, are slowing any bullish momentum. In addition, Iran and Iraq are currently increasing output, offsetting reductions in US rig counts and maintaining the supply glut.

Following this confliction, the market is moving significantly based on little more than rumours, particularly concerning an OPEC production cut. OPEC is very much an unpredictable quantity, with some members in favour of cutbacks, but most notably main producers Saudi Arabia standing by their market share for now. Saudi Arabia has been forced into economic cutbacks for the first time in several years as it has seen it’s heavily oil-dependent national revenue decline considerably. Thus, tension surrounds this issue, as investors know should it agree to scale back production, the price of oil will rise sharply.

To watch:

Exxon Mobil offers a certain ‘safe’ appeal for investors on the back of its integrated business operations and exceptional balance sheet. With limited downside appeal, and a dividend policy that has seen annual payouts increase for the last 33 years, its current low share price is yielding an attractive dividend rate – particularly given the floundering fundamentals of similar firms, e.g. BP, Chevron.

However, those looking for maximum capital gains will not be best served. Its stock price has recently diverged its trend with earnings, showing an increase in earnings per share of 12.40 last July to 16.46 presently. Simply, investors have already priced in its expected rebound. The risk lies in whether depressed oil prices persist long enough to dent its long-term profitability and threaten future dividends.

Proposed Trade: Short Sterling Energy (SEY)

Company Profile:

Sterling Energy is based in the UK but focuses on material exploration in Africa (specifically Mauritania, Madagascar, Somaliland, and Cameroon). The company reports that it is debt free, although concedes that its projects are only fully funded to the end of 2016 presenting significant liability.

Fundamentals:

Recently reported results:

  • For the six-month period ending 30 June 2015, the company reported a post-tax loss of $1.5 million.
  • This contrasts with the first half of 2014, which saw a $4.7 million profit.
  • Offshore drilling in Mauritania has consistently declined since the beginning of 2015. The firm plans to decommission this asset within the near future, and withdrew from Block C-3 in late January (29/1/2016).
  • The firm’s Somaliland project has been held up due to government restrictions over the level of security required to allow seismic and drilling operations to be conducted safely.
  • The firm acknowledges that the current low price of oil puts many of its existing projects in jeopardy.
  • The firm has seen the departure of its CEO and a director within the last year.

Share Price Performance:

The firm has seen a consistent decline in its share price over the past year. The 52-week range is 12.25–19.50 with a current price of 14.00. The past year has seen a decline in share price of 21.13%.

Today (30/1/2016), Sterling performed significantly more poorly than the energy sector on the London Stock Exchange (-1.75% across a sector average of +0.25).

The moving average convergence divergence (MACD) also exposes the stock as being over valued (net value of -0.02, divergence of -0.07) (note this is across the most recent 3 month period).

Sterling Energy also represents an attractive trade for the investment fund due to the relatively low value of its shares (£14.00 per share, relative to £159.75 per share for SOCO international, and £34.08 per share for Victoria Oil & Gas).