The oil price has been highly volatile in the last few months. Brent Crude, for instance, declined from $85 per barrel in October 2018 to almost $50 per barrel by the end of the year. Since then, there has been a partial recovery, with it currently trading at $60.
This has contributed to increased uncertainty among investors, with the share prices of oil producers such as Premier Oil (LON:PMO) and Tullow Oil (LON:TLW) falling heavily. Further volatility may be ahead in the near term, as supply and demand growth face mixed signals. But with the two stocks having low valuations, I think they may offer long-term recovery potential.
Value for money
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Based on their earnings forecasts for the current year, Premier Oil and Tullow Oil have P/E ratios of 4 and 12 respectively. Both figures suggest that the two stocks may offer margins of safety compared to their industry peers – particularly since they are making encouraging progress in improving their financial standing.
The two companies have adopted strategies aimed at increasing production, with the goal being stronger free cash flow and, ultimately, falling debt levels. Although there is still some way to go before their leverage is at more manageable levels, progress has been made in this regard. Premier Oil, for instance, recently reported that its debt declined by $390 million in 2018 so that it now stands as $2.3 billion. Tullow Oil’s net debt declined by $400 million in 2018 so that it is now $3.1 billion.
Production in 2019 is expected to rise at both companies on an underlying basis. They both have development pipelines which may catalyse their earnings growth potential in future years. While they may lack the size, scale and diversity of some of their larger FTSE 350 oil and gas peers, their financial performance has the potential to improve given favourable operating conditions.
Clearly, the two companies are highly dependent on the future direction of the oil price. As well as affecting their long-term profitability, it has the capacity to cause investors to become increasingly bullish or bearish, depending on its direction of travel.
On the supply side, there are mixed signals coming from major oil producers. While Saudi Arabia cut production last month, Russia increased its production to a record level. Plans to rebalance the oil market via the new Vienna agreement could take time to have an impact – particularly since supply will be higher than expected in the early part of 2019 following the decision to grant waivers to eight countries in respect of Iranian exports.
Demand for oil is also facing a mixed picture. The prospect of further US interest rate rises and a stronger dollar may mean that demand growth is limited. However, consumer demand appears to be high following the recent pullback in the oil price, which suggests that there may be some support at upwards of $50 per barrel.
While the future for the oil price remains uncertain, Premier Oil and Tullow Oil appear to have sound strategies. Their focus on reducing debt and increasing production could lead to greater profitability and lower risk. With low ratings, the two stocks could be of interest to less risk-averse, long-term investors.
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