It’s hard to miss the carnage in the resources sector.
The price of commodities, including oil, has plunged and taken profits and share prices with it.
Firms in the oil and gas sector are on the back foot, struggling with reduced cash flow, and facing hard decisions about whether or not to continue investing in projects for growth.
Bargains or bewares?
Falling share prices often tempt me. Temporary operational setbacks can throw up the possibility of a better value. However, that doesn’t work if setbacks prove to be more enduring problems for a firm’s operations. In such cases, a lower share price could mean zero change in the value we buy with our shares. A cheaper share price could even represent poorer value than the previous higher share price before operational conditions changed.
That’s why I’m not backing up the truck to fill it with oil company shares right now. All resources firms are cyclical to their cores and their fortunes depend on the fluctuations of the market prices of the commodities they sell. The price of commodities such as oil could swing back up this time in a cyclical move, but it might not. This time, oil could stay down near its historical lows in what could end up looking like a structural shift in the industry.
Drawing a lesson from Richard Farleigh’s book Taming The Lion, oil could fall further still from here, perhaps much further. All markets can move much further than we believe possible, he says. Imagine that — oil halving from here and staying there — if that happens we haven’t even begun to witness the destruction of businesses in the sector that could result. And why shouldn’t it happen? These are, after all, extraordinary economic times.
Now that I’ve cheered you up, let’s look at three potential investments in the oil and gas sector: Royal Dutch Shell (LSE: RDSB), Soco International (LSE: SIA) and Aminex (LSE: AEX).
Out with expensive exploration
Shell’s recent announcement of its intention to withdraw from further exploration activity in offshore Alaska is a good example of the tough choices facing oil companies. The firm discovered indications of oil and gas in its Burger J well, but not enough to warrant further exploration in the Burger prospect. Further exploration activity in Alaska will discontinue because of the Burger J well result, the high costs associated with the project, and the challenging and unpredictable federal regulatory environment in offshore Alaska, the firm says.
With reduced earnings due to the low oil price, Shell no longer enjoys the luxury of being able to throw money at hard-to-get and expensive-to-produce oil and gas, so that potential upside to any investment in Shell’s shares is gone. The firm’s share price is dropping hard, and I’d like to see it stabilise before even thinking about buying.
Strong production and no debt
Soco International produces oil from its assets in Vietnam. Earnings declined as the oil price dropped and the share price is around 65% down from the 448p or so it hit during 2014. However, the firm continues to make operational progress and boasts a strong financial position, with no debt on the balance sheet and low operating costs. The directors reckon attractive Vietnam production economics provide strategic flexibility that should ensure Soco navigates through the current lower oil price environment.
Soon to produce?
Exploration tiddler Aminex currently has no production but expects to produce gas from its discoveries in Tanzania soon. The Tanzanian authorities need to sign the firm’s Gas Sales Agreement and the timetable for that seems ‘flexible’. However, once signed, the subsequent gas sales should help accelerate the company’s other activities in the area. The worry here is that if gas production is put off for too long Aminex could face financial difficulties, which could lead to further fund raising events likely to dilute long-suffering shareholder’s interests. On the other hand, if production starts soon, Aminex’s future looks bright.
I’m more likely to go for the middle ground with any top-up investment and plump for Soco International. The firm’s strong balance sheet and well-established production sits well against upside potential from further exploration and development.
