Never miss an issue of Master Investor Magazine – sign-up now for free! |
Investing in the oil and gas sector is notoriously unpredictable. The price of oil has historically been exceptionally volatile, which has caused the share prices of industry operators to be difficult to predict in the short run.
Now, though, the industry could be about to experience a period of relatively high volatility. Supply disruption remains an ongoing threat, with the geopolitical outlook for a number of OPEC members being relatively uncertain. As such, the oil price could rise further, making FTSE 250 oil producers such as Premier Oil (LON:PMO) and Tullow Oil (LON:TLW) more appealing.
Uncertain outlook
While the price of Brent has failed to reach $80 in recent weeks, its outlook could be positive. Geopolitical tension in Iran, Venezuela and Libya has increased in the last few months, and there are concerns that there could be supply disruption. This situation could continue over the medium term, with the possible impact of sanctions in Iran potentially taking many months to be felt.
Supply disruption could offset the expected increase in production from OPEC and non-OPEC members following agreement to achieve compliance with the Vienna Agreement. This entails higher production, and could mean that it reaches a record high. The prospect of this, however, has done little to hurt the oil price in the short term. In fact, investors seem to be concerned about the reduction in the world’s spare capacity cushion. This may amplify the impact of supply disruption in future.
In terms of demand, there are concerns that higher oil prices could negatively impact world economic growth. However, the International Energy Agency (IEA) expects world oil demand growth in 2019 to be at the same level as in 2018. This suggests that while consumers may be unhappy with recent oil price rises, they may not yet be sufficient to have a negative impact on demand. Should supply be disrupted, stable demand means that the oil price could move substantially higher.
Investment appeal
Although the prospects for the oil and gas industry remain uncertain, stocks such as Tullow Oil and Premier Oil appear to trade at discounts to their intrinsic values. The two companies have forward P/E ratios of 9.8 and 5.1 respectively using 2019’s forecast EPS figures. Their valuations suggest that they offer margins of safety in case of a pullback in the price of oil, should this result from the planned higher production of countries such as Saudi Arabia and Russia.
Tullow Oil and Premier Oil are both in the process of ramping-up production as they seek to strengthen their cash flow and balance sheets. Debt reduction at both companies could lead to a more sustainable growth outlook, as well as more favourable risk/reward ratios for new investors. Although volatility will always remain due to their dependence on the ever-changing oil price, the two stocks could offer improving share price performance over the medium term.