With the oil price recently reaching $60 per barrel for the first time since July 2015, many investors are becoming more bullish on the outlook for oil and gas companies. After all, a higher oil price could mean that their profits also move upwards.
However, the oil price faces sustained pressure from the impact of new technology, while demand from the emerging world may not be as strong as previously expected. Further, rising production from non-OPEC producers may also limit the progress of the oil price in the near term.
Still, with valuations potentially being low and a number of companies in the sector having adapted their business models to a low oil price environment, could these two stocks be worth buying for the long term?
Potential difficulties
While oil trading at $60 per barrel is an encouraging sign for the industry, there is no guarantee that it will continue to rise. According to the International Energy Agency (IEA), non-OPEC oil production is expected to grow at the same rate as demand in 2018. This could mean that three of the four quarters next year will see demand and supply being in balance. This could limit the scope for higher oil prices during the period.
Furthermore, the longer term outlook for the oil price may also be somewhat challenging. Efficiency and technology continue to move against the prospects for oil, with some estimates putting the figure at a reduction in demand each year of between 500,000 and 600,000 barrels of oil per day. With China pivoting towards a greener, consumer-focused economy and seeking to become less reliant on infrastructure and heavy industry, the overcapacity issues of recent years may not be overcome in the near term by the oil and gas industry.
Investment opportunities
Of course, the oil and gas industry could still provide investment appeal in the long term. Valuations across the sector appear to be relatively low due in part to the lacklustre performance of the oil price in recent years. For example, Shell (LON:RDSB) and Tullow Oil (LON:TLW) now trade on prospective P/Es of 16 and 20 respectively despite them having relatively upbeat growth potential.
In the case of Shell, it is forecast to significantly increase its free cash flow in the medium term. This is partly because of the impact of the acquisition of BG, but is also due to an efficiency drive. This could stimulate dividend growth and boost its 6% dividend yield. With its Q3 update showing it is making progress regarding profitability and with asset disposals potentially ahead, it could deliver a rising share price.
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Similarly, Tullow Oil appears to have a sound strategy. The company is increasing production, with its TEN field coming on-stream in mid-2016. This is due to help the company move back into profit in 2018 and could lead to reduced debt levels and a more sustainable growth outlook.
Outlook
Therefore, while the recent rise of the oil price may be limited to some degree by advances in technology, a transitioning China and a lack of supply deficit in 2018, there may be compelling investment opportunities which offer high total return prospects for the long term.
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