Oil has been on an astonishing rally since the beginning of 2016.
The price of black gold has risen by more than 70% since the January lows. Brent crude currently trades at around $50 a barrel, up from around $30 a barrel as printed in the middle of January this year.
And as the price of oil has pushed higher, shares in oil producers have also recovered from their lows. In many cases, these shares have outperformed the underlying commodity.
For example, since mid-January shares in Tullow Oil (LSE: TLW) have gained more than 100%, easily outperforming all of the UK’s major indexes and racking up one of the best performances in the FTSE All Share.
However, it looks as if Tullow will struggle to match this performance going forward. Over the past month, the rally in the company’s shares seems to have run out of steam and over the last 30 days Tullow’s shares have lost 3.5%.
Reconsidering
It looks as if investors and now reconsidering their decision to rush to buy oil explorers during the first five months of 2016. Earlier in the year, with many explorers trading at extremely distressed valuations, the risk of buying into the sector was more than offset by the upside potential available. Now, after recent gains, many explorers are trading at premium valuations, which leaves little room for mistakes and as a result, the risk-reward profile no longer seems attractive.
Like Tullow, Enquest (LSE: ENQ) and Premier Oil (LSE: PMO) have both racked up some impressive gains since mid-January. Since January 26 shares in Premier have risen by more than 270% while shares in Enquest have gained 158%. But once again over the past month, the rally seems to have run out of steam. Enquest’s shares are down by 1.5% and shares in Premier have returned 5.8%.
Does this make sense and are the premium valuations these explorers now command really premium? It would seem so. Take Tullow Oil, for example.The company’s shares currently trade at a forward P/E of 76 for the year ending 31 December 2016. City analysts have pencilled-in earnings per share growth of 270% for the year ended 31 December 2017, but even if the group hits this forecast the shares will still be trading at a high valuation of 21 times forward earnings.
Meanwhile, Enquest and Premier aren’t expected to report a profit for the next two years, so it’s almost impossible to place a value on the shares of these two companies.
With this being the case, and after recent gains, it looks as if the market has got ahead of itself with these three explorers. The oil market hasn’t returned to normality, and there’s still a lot that could go wrong for Enquest, Premier and Tullow.
The bottom line
So overall, after recent gains, it might be wise to stay away from this trio as they may never return to previous highs.