Oil stocks such as Premier Oil (LSE: PMO), Tullow Oil (LSE: TLW), Enquest (LSE: ENQ) and Genel Energy (LSE: GENL) have delivered a storming performance for investors over the last couple of weeks.
Backed by a rebound in the price of oil, shares in these companies rose by as much as 40%:
|
Company |
30/9 – 14/10 gain |
|
Tullow Oil |
43% |
|
Premier Oil |
39% |
|
Genel Energy |
28% |
|
Enquest |
15% |
Unfortunately, the boost in oil prices which seemed to trigger this sudden recovery is now fading away. Oil prices are back down below $50 per barrel, which seems to have put the brakes on any further equity gains.
In this article, I’ll explain what the likely outlook is for the oil price over the next year. I’ll also ask whether shares in these oil companies are now fully priced.
Still too much oil
The two main oil industry associations, OPEC and the International Energy Agency, agree on at least one thing. Oil production is still higher than oil demand.
Things are improving, however. Low oil prices and a shortage of new funding is starting to affect US oil production, which is expected to fall by more than 500,000 barrels per day this year. Production is also starting to fall in Russia, Canada and the North Sea.
Cheaper oil prices have boosted demand, but both the IEA and OPEC expect the rebalancing process to stretch out well into 2016.
Is $60 the new $100?
The other thing to remember is that while US shale production is falling sharply, shale wells are quick and cheap to drill. New oil can be flowing within 3 months of a decision to start drilling.
Industry estimates suggest that the average breakeven level for US shale oil is $60-65 per barrel. I expect that if oil prices climb anywhere close to $60, new production will rapidly come online in the US. This could effectively put a cap on oil prices for the next year or two.
What about oil stocks?
The four firms I’ve mentioned above are each in slightly different positions.
Kurdistan operator Genel Energy looks cheap based on its reserves, but faces big political and operational risks. Payments for oil exports are slow to arrive and heavily in arrears. The firm also faces the risk of the ISIS conflict escalating into the region in which it operates.
On the other hand, Genel has a lot of very cheap oil and will make money at current oil prices, if payments become more reliable.
In contrast, Tullow, Premier and Enquest don’t have any major problems with security or payments, but they do need higher oil prices to make a decent level of profit. My estimate would be at least $60 per barrel.
All three of these firms have also borrowed heavily to complete major projects. This could mean that shareholder returns are lower than expected over the next few years, as each company concentrates on using cash flow from new production to reduce debt.
For all companies, the recent share price gains probably weren’t excessive. Most oil stocks were probably oversold in September.
However, I wouldn’t chase the shares any higher at the moment. With oil drifting lower, share prices are likely to follow. The next few weeks could offer better buying opportunities.