ALL sorts of conspiracy theories are being put around as explanations for the dramatic decline in oil prices since the end of June.
Saudi Arabia’s bid to kill off the US shale boom is one of them, yet the kingdom is working on behalf of Washington to bring Russia and Iran in to check.
But behind the puzzle are reasonable questions around why Saudi Arabia, as the world’s big swing producer of oil, has not responded to the price slump with some good old-fashioned production cuts.
The average investor in oil stocks need not worry about any of that. All that needs to be known is that since the end of June, the North American benchmark price (West Texas Intermediate) and the European benchmark (Brent) are down by 21 per cent to $US81 a barrel, and 23 per cent to $US86 a barrel, respectively.
Such dramatic falls create opportunities and it is argued here that the greater opportunities lie among the junior oil and gas producers and explorers.
As a sector, they have been smashed since August when oil’s price decline really got going. The 25-35 per cent share price falls among smaller operators compares with the much more sedate 5-10 per cent falls of the big producers.
The common explanation for that from the market analysts is that the weight of opinion — as reflected in futures markets — is that oil will head back to $US100 a barrel before long: that is considered the inducement price needed to ensure the not insubstantial task of pumping out more than 32 billion barrels of the black stuff annually is achieved.
But if it is good enough for Woodside, Santos, and the other big oil and gas stocks to only cop 5-10 per cent price falls, what’s the issue for the juniors?
It is a question that Baillieu Holst analyst Adrian Prendergast has had a good look at in a recent energy sector report.
He may well have found the answer, too.
Prendergast reckons that unlike the beaten-up junior iron ore producers, the energy sector is unique in that continuing strong margins mean that the decline in oil is not a material risk to the health of the sector. But they are being treated as if their margins have disappeared.
Prendergast did not dwell on the explorers but it can be said that oil’s fall from $US112 a barrel (Brent) at the end of June to $US86 a barrel this week does not affect the discoveries they have yet to make, if that makes sense.
The leverage of these juniors to a discovery is intact, and in some cases can be extreme. Woodside could find a 200 million-barrel field off the east coast of Africa and its share price would barely move. For a junior, it would be a case of off to the races.
Prendergast is slightly more bearish than market consensus on oil prices in the 2015 financial year. He has got oil (Brent) at $US99 a barrel compared with consensus of $US106 a barrel.
Taking that, he has penned in Senex Energy (SXY) as a buy, with a price target of 88c compared with yesterday’s price of 49.5c. Lonestar Resources (LNR) is also a buy according to Prendergast, with a price target of 43c compared with 34.5c in yesterday’s market. American Patriot Oil & Gas
AMERICAN Patriot Oil & Gas (AOW) has not wasted any time in joining the ranks of ASX-listed junior oil and gas producers, as distinct from the explorers.
Only listed back on July 8 — July 4 would have been more appropriate perhaps — the company has just become a commercial oil producer from a well on the Lustre field in Montana’s western Williston basin.
The well has settled down to a stabilised average flow rate of 216 barrels a day. So it’s not big by any means. But even at the lower oil price of $US80 a barrel, the payback on the cost of well is all of six months, with every likelihood the well will still be giving in 20 years’ time.
More than that though are the 17 follow-targets — all defined by modern-day seismic data — that the company and its joint venture partners will proceed to follow up, plus the series of wells to test the unconventional or “tight’’ oil potential of the field.
The field, known for carbonate zones with low permeability, was under the umbrella of the mighty Exxon back in the early 1980s but was shut in 1986 when a supply glut pushed oil prices to below $US10 a barrel (an inflation adjusted $US22).
Horizontal drilling has advanced since then, so the upcoming unconventional wells could be worth watching for the newbie, which had a last sale of 19.5c, just under the July issue price.
AOW Price at posting:
19.5¢ Sentiment: Buy Disclosure: Held
