The financial pundits earlier this year were certain in their apocalyptic warnings that crude prices were headed for $20 or even $10/bbl. Instead, Brent crude has rallied 50% from January lows. Although we may not return to the halcyon days (for crude producers, at least) of $100/bbl or more, will these rising prices send oil producers’ shares skyrocketing?
Royal Dutch Shell (LSE: RDSB) did well to take advantage of the collapsing oil prices and its healthy balance sheet to snap up rival BG Group. Although the £35bn deal was expensive, it makes Shell the world’s largest liquefied natural gas (LNG) supplier and adds significant low-cost-of-production oil fields.
Although the market initially reacted negatively, I believe this deal will prove wise in both the short and long term. Over the next few quarters, BG’s assets will help maintain Shell’s high dividend as long as crude reaches the mid-$40/bbl range. And, in the long term, Shell will be well placed to take advantage of the shift from oil to LNG occurring in many countries due to cost, reliability and climate change issues.
Going forward, the company’s healthy balance sheet (gearing will be in the low 20% range after the BG deal), 7% yielding dividend and great range of low cost assets could make it a big winner for investors.
Slow burn
Minnow Cairn Energy (LSE: CNE) may be the polar opposite of diversified major Shell. Cairn currently produces no oil after spinning out its Indian operations years ago. After several disappointing years searching for its next jackpot in Greenland and Morocco, the company’s shares have rallied on the news that its Senegal operations could be a massive winner.
Several successful test wells in the West African nation have buoyed the company’s long-term outlook. Furthermore, the short term doesn’t look too bad either for Cairn. The company’s interests in the UK North Sea are set to begin pumping first oil early in 2017. With break-even prices of $14-$20/bbl, the significant cash from these operations will be funnelled into building out Senegalese drilling.
With a renewed focus on low cost assets in the short term and a potential blockbuster for the years ahead, Cairn certainly offers significant upside. Prospective investors would be wise to exercise caution though, as building the first deep water wells in Senegal will take years and potentially billions in capital spending.
Upward rerating?
Tullow Oil (LSE: TLW) knows well how long it can take to build infrastructure from the ground up in West Africa. First oil from the company’s massive TEN Field off the coast of Ghana is expected in 2016 after years of waiting. This project couldn’t come soon enough for the company after racking up net debt of $4bn for a staggering 56% gearing ratio.
Looking ahead, the addition of TEN to other low-cost assets means free cash flow will ramp up significantly in the coming years as capital spending falls. If crude prices keep rising, and Tullow’s goal of 33% higher production in 2017 comes to pass, the company could be in very good shape. And, with shares trading at a respectable 15 times 2017 forecast earnings, there’s potential for significant upward rerating.