For investors seeking to buy low and sell high, the energy sector holds considerable appeal. Certainly, there is a good chance that the prices of commodities such as oil and iron ore will weaken over the short to medium term and, as such, the share prices of energy companies could come under pressure.
But, looking at the long term energy needs of the global economy, there is still reason for optimism for investors in the sector. And, with valuations having tumbled in recent months, now could be a good time to increase your exposure to the troubled sector.
Financial Risk
As well as the risk of further commodity price falls or, in the case of oil, a return to the slump that saw it trade below $50 per barrel before spiking to $60, there are other risks to consider. Chief among them is cash flow and this is highly relevant to investors in Genel (LSE: GENL). It is focused on the Kurdistan region of Iraq and has an excellent asset base from which to produce oil and profitability for investors moving forward.
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The problem, though, is that the region is politically very unstable and, while payments have been made to operators in the region (such as Genel) by the Kurdistan Regional Government (KRG), there is considerable uncertainty regarding future payments, which is a major concern for investors.
Diversity
Genel also suffers from lacking significant diversity. For example, while energy majors such as Shell and BP have multiple assets in a variety of different locations, and so can overcome challenges posed by one or more assets at the same time, Genel is focused upon Kurdistan/Iraq. This means that it is highly sensitive to external events in the region and, while the company appears to be making considerable progress, external challenges may cause its share price to be hit hard.
This, however, does not appear to be the case for Rare Earth Minerals (LSE: REM). It has stakes in four main projects, from Australia to Greenland, and from Nevada to Mexico. As such, it seems to suffer from less political risk than Genel and, while demand for lithium may not be as high as for oil at the present time, it is a market with considerable potential that could lead to impressive returns for Rare Earth Minerals in the long run.
Looking Ahead
Despite this, Rare Earth Minerals is still not expected to post any revenue figures in either of the next two years. As such, it makes valuation more challenging – especially while there are other energy plays such as Sound Oil (LSE: SOU) and Genel which are forecast to be highly profitable during the same time period.
For example, Sound Oil is expected to move from five years of losses to a pretax profit in the current year, before delivering a pretax profit of £4.3m next year. This puts it on a price to earnings growth (PEG) ratio of just 0.1, which indicates that it offers good value for money. Likewise, Genel trades on a PEG ratio of 0.2, which indicates that its potential reward compares favourably to the aforementioned risks that come with investing in it.
So, while all three stocks have clear long term potential, it may be prudent to stick with the likes of Sound Oil and Genel since, unlike Rare Earth Minerals, they are set to be profitable this year and, as a result, are easier to value and could benefit from improved sentiment as their profitability rises.
