Investors have fled the oil & gas sector over the past few weeks, as the price of oil has plunged to lows not seen since the financial crisis. But after these declines, companies like BP (LSE: BP), Enquest (LSE: ENQ) and Afren (LSE: AFR) look attractive on a valuation basis.
Indeed, according to current City figures these companies are trading at forward P/Es of 9.8, 3.9 and 2.8 respectively. However, these figures are highly misleading.
Fast moving market
The price of oil has become extremely volatile over the past few weeks and this is a huge problem, not just for oil production companies but also for investors.
You see, most investors, both private and professional, factor in the price of oil to assess the earnings potential and asset values of oil companies. Unfortunately, with the price of oil falling so quickly — upto 5% in one day — these forecasts are out-of-date almost as soon as they are put together.
Furthermore, with oil trading at record lows, these companies are having to take write-downs on the value of their reserves. Tullow Oil (LSE: TLW) for example, has warned that this year it will book a record $2.7bn write-down, as previous discoveries now have no prospect of being profitably developed at current oil prices. This revelation came as a shock to the company’s shareholders but serves as a warning to other investors.
Genel Energy (LSE: GENL) has also disappointed recently, cutting its revenue forecast for this year by $150m–$200m, to a range of $350m to $400m. These figures are relatively conservative — they are based on oil prices of around $50 per barrel, down from the $80 on which the company based previous forecasts.
Unfortunately, the rest of the industry is not taking a similar conservative approach. According to a recent report from FactSet Insight, many oil sector analysts are overly optimistic on the sector’s outlook. Most believe that the price of oil will rebound within the next few months, although there’s no guarantee that this will be the case.
That’s why investors need to be cautious around oil companies, as it’s now almost impossible to find an up-to-date and accurate set of figures.
That being said, for a company like Enquest, which has hedged 80% of its 2015 production at a price in the high $80s, the figures are more reliable, although there’s still a degree of uncertainty.
Additionally, the integrated nature of BP means that it can continue to profit while the price of oil falls, as the group’s refining margins expand. Management has stated that for every $1 improvement in the profit margin for refined products, BP generates an additional pre-tax operating profit of $500m.
Multiple mistakes
Enquest, BP, Tullow and Genel are suffering as the price of oil falls, a factor they can’t control. Afren on the other hand has now made so many mistakes, it’s questionable whether or not investors can continue to trust the company.
With output falling and an incomplete management team, Afren announcement more dismal news this week, revealing that contrary to previous statements, there were no proven or probable reserves at its Barda Rash oilfield in Iraqi Kurdistan. The company is also running out of cash.
Afren is currently taking advice on restructuring its finances and is seeking to delay a $50m debt payment due at the end of January. It seems as if the company’s final lifeline is a takeover bid from fellow Nigerian operator Seplat.
