As the price of oil languishes at a multi-year low, there are plenty of bargains seemingly to be had in the petroleum sector.
However, picking a single stock as a play on the sectors recovery is a risky bet. Picking stocks is tough. Even the so-called experts get it wrong most of the time. Thats why investors should always build a well-diversified portfolio, to reduce risk and improve their chances of long-term wealth creation.
And with this in mind, the best way to play a recovery in oil prices could be with a broad selection of oil producers and explorers. Four of the best producers and explorers areGulf Keystone Petroleum (LSE: GKP),Premier Oil (LSE: PMO),Falkland Oil and Gas(LSE: FOGL) andFrontera Resources(LSE: FRR).
Four diversified plays
Gulf Keystone, Premier, Falkland, and Frontera are four different companies, in four various stages of their lives, all operating in four different regions around the world. You couldnt pick a more diversified basket of stocks.
Frontera Resources is the smallest of thegroup, but that doesnt mean that the company should be avoided. Frontera is a small company with big ambitions. Management is targeting production of7 million cubic feet per day of gas and approximately 1,000 bbls per day of oil by the end of 2015.
Fronteras exploration activities withinGeorgia have also yielded significant results. The company believes that itsSouth Kakheti Gas Complex is a world-classgas play, which could yield substantial results for the company over the long-term. Moreover, unlike many other small-cap oil and gas explorers, Frontera is already generating revenue. Revenuesfrom crude oil and gas sales totaled $3.2m during the first half.
Falkland Oil and Gas isnt generating any income, but the companys cash-rich balance sheet will help it fund the development ofits prospects in theFalkland Basins. These prospects look set to yield excellent production numbers over the medium to long-term.
Falkland and its regional peer,Rockhopper Exploration,are planning to begin oil production from the Falklands prospects, assuming everything goes to plan, by 2019. The recently revised field development plan will cost the two companies $2bn. And as Ive writtenbefore if everything does indeed go to plan, Falklands shares could rise bymore than 700%.
Oil producers
Both Frontera and Falkland are exploration plays, Premier Oil, and Gulf Keystone are two production plays currently trading at rock-bottom valuations.Premier is trading at a low not seen since the financial crisis, but 60% of the companys production for the rest of the year is hedged at $92/bbl, and 30% of 2016 production is hedged at $68/bbl.
Analysts are expecting a pre-tax profit of 65m for 2016, andPremiersprincipal $2.5bn bank facility is not up for refinancing until mid-2019. So, the group has plenty of balance sheet flexibility.
Gulf Keystone is also trading near its all-timelow, but the company is in a strongerposition now than it has been for many years. Payments from theKurdistan Regional Government have started to arrive, and the company is finally starting to repair its bruised balance sheet.
Gulf Keystones production costs are some of the lowest in the industry, so the company is better placed to weather the industrys storm more than most.
Optimal diversification
Most studies agree thatinvestors can achieve optimal diversification with only 15 to 20 stocks spread across multiple sectors, although many investors prefer a higher number, holding several different stocks from each sector to further increase diversification.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.