AIM Oil & Gas – 2013 likely to kick off takeover activity

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This year has been mixed for some sectors of the equity arena, even though at the headline level the likes of the S&P 500 are actually substantially higher YTD. The first few months were great for the bulls but then everything turned negative as economic fears in China, Europe and even the U.S. weighed on investors’ minds, and prompted them to search out safe havens as detailed in our bond bubble blog here –

SBM has been searching for value inside the market in recent months and looking for the most undervalued assets which may be able to deliver a hefty return into 2013. One of the sectors we have alighted upon aside from Japan, China and the Mining arena is the Oil & Gas sector. Our magazine issues in February and September looked deeply into the Falkland Islands stocks prospects and and also some undervalued gems that we think have positive risk:reward potential within the AIM Oil & Gas sector. It is now time to take another look at this battered sector and try to assess the path it will follow next year…

The Financial Meltdown

In May 2008, the AIM Oil & Gas sector was hovering around 6,100. Yup, that’s no error – 6,100! It was valued at almost two times what it currently is. In just a few months between May 2008 and March 2009, the sector lost three-quarters of its value and traded below 1,600 for some time. With a financial crisis threatening the whole world economy, demand for oil was significantly cut and thus oil prices came down from a high above $140 to hover around $40. In such an environment there was no hiding for illiquid, high risk AIM Oil & Gas plays and many stocks were truly decimated.

With the recovery of the U.S. economy, the oil sector also recovered and the AIM Oil & Gas index hit 5,500 at the beginning of last year but suddenly dropped again in the mess that was 2011 in geo-political terms. Conflicts in the MENA region and the earthquake in Japan did push oil prices up for a while but the debt ceiling debacle in the U.S. and consequent downgrade in the credit rating of the country led to a massive selloff in equities in August and similar declines in commodities. As a result, from 5,500 registered in the opening months of 2011, the AIM Oil & Gas sector retreated 38% and closed the year at 3,419.

Unfortunately, 2012 has not been much better than 2011 for the sector. Again, it started with some strength rising to 5,000 in February but then dropped again and currently trades around 3,342, a drop of 2.25% YTD.

China’s economic slowdown, the U.S. economy growing at less than desired by the Fed, several downgrades to the World’s growth prospects, the Japan-China crisis, European sovereign yields rising…these are just some of the reasons why oil has struggled to rise this year. Brent crude managed to rise 2% so far but its Light Sweet counterpart is down 10% – an opportunity we have touched upon previously with regards to the oil spread widening and offering an opportunity in the mid $20’s differential range to short Brent and buy Nymex.

The AIM Oil Companies

With the oil price off its peak, the actual costs of exploring and drilling still have become more expensive for the smaller companies that make up the the AIM sector. This is putting lethal pressure on some of those companies as they try to raise cash in an increasingly difficult environment and, as is illustrated so aptly in the case of the Falkland Islands stocks. At $200 a barrel, hell I would even try and dig in my own backyard and try my luck but with the current oil price being under pressure, some projects may in fact need to be abandoned given the exploration costs. This is likely however to kick of a spate of farm-ins or takeovers – the real question is choosing those companies where they are not, excuse the pun, literally “over a barrel” and need to give the assets away at the detriment of current shareholders – this in fact is the questions hanging over what are extremely undervalued companies like BOR, XEL & BLVN. Management know the stock is worth more but they don’t have the muscle to raise cash on attractive terms, hence the discounts languish…

Adding to the pressure from current moribund oil prices and some drilling disappointments, we must also consider the effects of the debt crunch. At a time when banks are deleveraging just where can these small companies get the funds they need? That’s a question many Oily CEO’s would love to see answered and as they have been out to their & their shareholders cost in recent months. Sentiment is battered down and it will take some time to recover.

The Future

With the fiscal cliff problem currently remaining on the table, oil prices will likely continue to go sideways for the near terms. If there is a resolution however in the very near future then get set for an explosive Christmas rally. We suspect that this type of “risk-on” catalyst is required in order to pull the AIM oilies off their oversold floors and historically the days over the Xmas period have delivered some exceptional returns to stock holders in these companies.

At current prices, and as has been referred to many times by us here at SBM, a lot of the AIM Oil & Gas sector are prime takeover targets. The next year will see improved economic conditions in Europe and the U.S. and the fiscal cliff will (hopefully) be a distant memory. With renewed momentum in the global recovery, oil prices will kick in, and so most likely will oil share prices.

For now we leave you with some data from the AIM Oil & Gas Sector for you to take a look. Don’t forget to also take a look at our picks in the September edition of our Magazine ( p. 35). During 2013 we think Ithaca, Bowleven, Xcite, Gulfsands and Borders & Southern will most lilkely attract predatory attention.


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