Investors have fled the oil & gas sector over the past few weeks, as the price of oil has plunged to lows not seen since the financial crisis. But after these declines, companies likeBP(LSE: BP),Enquest(LSE: ENQ) andAfren(LSE: AFR) look attractive on a valuation basis.
Indeed, according to current City figures these companies are trading at forward P/Es of 9.8, 3.9 and 2.8 respectively. However, these figures are highly misleading.
Fast moving market
The price of oil has become extremely volatile over the past few weeks and this is a huge problem, not just for oil production companies but also for investors.
You see, most investors, both private and professional, factor in the price of oil to assess the earnings potential and asset values ofoil companies. Unfortunately, with the price of oil falling so quickly upto 5% in one day these forecasts are out-of-date almost as soon as they are put together.
Furthermore, with oil trading at record lows, these companies are having to take write-downs on the value of their reserves.Tullow Oil(LSE: TLW) for example,has warned that this year it will book a record $2.7bn write-down, asprevious discoveries now have no prospect of being profitably developed at current oil prices. This revelation came as ashock to the companys shareholders but serves as a warning to other investors.
Genel Energy(LSE: GENL) has also disappointed recently, cutting its revenue forecast for this year by $150m$200m, to a range of $350m to $400m. These figures are relatively conservative they are based on oil prices ofaround $50 per barrel, down from the $80 on which the company based previous forecasts.
Unfortunately, the rest of the industry is nottaking a similar conservative approach. According to a recent report fromFactSet Insight, many oil sector analysts are overly optimistic on the sectors outlook. Most believe that the price of oil will rebound within the next few months, although theres no guarantee that this will be the case.
Thats why investors need to be cautious around oil companies, as its now almost impossible to find an up-to-date and accurate set of figures.
That being said, for a company like Enquest, which has hedged 80% of its 2015 production at a price in the high $80s, the figures are more reliable, although theres still a degree of uncertainty.
Additionally, the integrated nature of BP means that it can continue to profit while the price of oil falls, as the groups refining margins expand. Management has stated thatfor every $1 improvement in the profit margin for refined products, BP generates an additional pre-tax operating profit of $500m.
Enquest, BP, Tullow and Genel are suffering as the price of oil falls, a factor they cant control. Afren on the other hand has now made so many mistakes, its questionable whether or not investors can continue to trust the company.
With output falling and an incomplete management team, Afren announcement more dismal news this week, revealing that contrary to previous statements,there were no proven or probable reserves at its Barda Rash oilfield in Iraqi Kurdistan. The company is also running out of cash.
Afren is currentlytaking advice on restructuring its finances and isseeking to delay a $50m debt payment due at the end of January. It seems as if the companys final lifeline is atakeover bid from fellow Nigerian operatorSeplat.
All in all, if you are thinking about buying any of the above oil stocks, you need to be prepared for a rocky ride.
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