Stephan Bogner | May 18, 2015 07:25AM ET
Capitalizing on the panicked sell-off in junior oil and gas stocks may prove to be a smart move now, as oil prices have recovered some 50% since crashing to $42/barrel WTIC in March, whereas many juniors still trade at relatively low levels.
While some experts are still bearish awaiting their earlier forecast of a final drop below $40, others expect oil to recover to $75 in the near-term as this level represents global marginal cost of production. Investment banker Angelo Damaskos, Principal Adviser of the Junior Oils Trust, admonished recently:
“The longer oil trades below that price level, we lose supply not only from the North American shale industry, but also from the longer-term producing projects: the Canadian tar sands and the Brazilian offshore basins. The oil price has recovered by 20-25% from January's lows but remains 50% lower than last year's highs. As a result, there has been a dramatic drop in income and earnings, which has been met with big cutbacks in capital expenditure (capex) and development drilling. The length of time oil trades below $75/bbl is a clue to how strong the recovery might be once a supply-demand balance is again achieved."
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“It’s intriguing to me how all the surprises in the energy market in 2015 have been bullish. Global demand around the world for oil is higher than anyone expected at these lower prices. Another one is the drill rig count in the US – nobody thought the producers would have that much discipline to drop that many rigs that fast.“
The rig count – a proxy for activity in the industry – is down 58% since a peak of 1,609 rigs in October. Paul Ausick said on May 9:
“In less than 5 months, the country lost more than half of all its oil rigs. While the number is remarkable, even more remarkable is the speed with which the spigot has been turned off. We may be about to find out how quickly that spigot can be turned back on.“
Looking at the impressive rebound of oil prices since March, he interprets this as “the strongest signal yet to producers that demand is returning, and as demand returns so will production.“ Phil Flynn from Price Futures Group said on May 15:
“As the rig-count cut slaughter continues…we will see it impact output more and more over the coming weeks and months.”
The tide is already turning in the futures market, according to Paul Ausick:
“Hedge funds — under the Managed Money heading in the Commodity Futures Trading Commission (CFTC) Commitments of Traders report — increased their long positions by about 1,500 contracts last week and reduced their short positions by about 7,500 contracts. The decreases reflect changes due to the May 5 settlement date. Managed Money holds 340,604 long positions, compared with 74,294 short positions. Among the producers themselves, short positions outnumber longs, 398,478 to 233,630. But the number of new long positions last week was double the number of new shorts. Positions among swaps dealers show 360,469 shorts versus 196,807 longs. Swaps dealers increased their short positions by a total of nearly 17,000 contracts last week.“
This appears to be an opportune time to build positions in oil and gas developers and producers, whereas ample focus can be put on companies active in the US and reporting in Canadian dollar. Geoffrey Smith from Fortune recalled last month:
“When a commodity price collapses, it’s only natural to see a shakeout among the companies that produce it. The weak go the wall and the strong salvage from the wreckage what they think will make them stronger.“
Such statements serve well to look for oil and gas developers, as well as producers, in the red and on the way becoming profitable again with higher prices, and/or ready to be swallowed by seniors for peanuts at such low price levels as today.
“The proposed takeover of BG Group (LONDON:BG) Plc by Royal Dutch Shell (LONDON:RDSa) illustrates the opportunity available to cash-rich companies. Shell, like other supermajor, integrated companies, has been suffering from declining reserve life and insufficient production replacement for years. Its 2014 reserves replacement ratio was 49%, of which only 17% came from exploration. Meanwhile, its 2014 reserves life index declined to 11 years from 12.3 years in 2013. In the present environment, it is cheaper to buy proven reserves than pursue expensive and risky exploration. British Gas carries substantial debt and had to take huge write-downs as a result of the price drop because many of its assets have been impaired. Nevertheless, BG offers Shell very large proven reserves and production in a global portfolio, as well as attractive development projects in emerging regions such as Australia and Brazil. Shell got BG at a very attractive price, and this deal sorts out its declining reserves problem. Shell also gains a much-larger global presence and will likely realize savings deriving from the elimination of duplicated functions. Shell expects the oil price to recover to $90/bbl by 2018. So the industry is fairly bullish on long-term oil prices, and we expect the pace of M&A to accelerate.“
-Angelo Damaskos, CEO of London-based Sector Investment Managers Ltd., a regulated investment advisory company, in a recent interview; Damaskos worked a decade for the European Bank for Reconstruction & Development
“Despite the drilling permission, the stock market is not really euphoric yet. The stock rose slightly from 28 to 29.50 euro. However, the stock declined during the week. Maybe the skepticism is still big because the company, like the rest of the industry, is still struggling with the oil price decline since last year, in which time the price halved. The first quarter of this year saw a substantial drop in Shell’s profits. The operating profit decreased more than half to 3.2 billion USD. However, this is still 2.5 billion USD more than analysts calculated and expected. The energy giant still has ambitious plans. In this year alone, the company has sold assets worth more than 2 billion USD. In April, the take-over of BG Group for 47 billion GBP was announced. By that, a stronger company shall evolve.“
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