Two small oil stocks with huge upside potential

They may not produce any oil yet, but big returns could be on the horizon.

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The upside potential for shares of Hurricane Energy (LSE: HUR) stem from the fact that the company currently produces no oil but owns the rights to what is beginning to look like a massive field off the coast of the UK. The latest drilling in this Lancaster field indicates that it could hold more than the 200m barrels it’s currently thought to contain.

Now, investors shouldn’t get too excited yet as this is likely to be a long journey. The company is currently in the process of drilling a second test well, so first oil is a long way off, even if it produces good results.

Furthermore, with £57.4m of cash on the balance sheet after a rights issue the company will need to tap other sources of capital if the time does come to drill proper wells. Investors interested in Hurricane should exercise caution and wait to see what sort of deal is struck with financiers to fund future projects.

And, this being an offshore project in the UK North Sea, drilling isn’t exactly an easy proposition. That’s why Hurricane is currently forecasting operating costs per barrel of $26. Include what will be a very large bill for capital expenditures to get the project on-line and Hurricane shareholders should be hoping for substantially higher oil prices by the time production begins.

More attractive?

One prospective oil producer that’s much closer to the pot of gold at the end of the rainbow is Cairn Energy (LSE: CNE). Cairn has been searching for new projects for several years now after selling off its Indian operations. The long search appears to be over as the company is expecting first oil from its stake in two UK North Sea developments in the first half of 2017.

Cairn looks more attractive than Hurricane for two key reasons. First, it’s closer to production with UK offshore developments expecting first oil in early 2017. Second, with operating costs of $20/bbl and $14/bbl at the two fields, the economics of Cairn’s project make more sense.

And best of all, Cairn has found what it believes is a world class field in the much cheaper waters off the coast of Senegal. While it’s still early days for this possible project, the economics of it are eye-catching to say the least. Cairn is projecting operating costs per barrel of under $10 and total breakeven prices of $35/bbl. That means this development would be generating profits even in today’s low oil price environment.

This project is still years away from producing anything though. From the time the company makes its final investment decision it’s expected to take three-to-five years to reach first oil. The good news is that Cairn’s North Sea assets should be on-line by then and cash generated from these developments can be funnelled into Senegal, hopefully reducing the need for significant sources of outside financing.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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