Oil stocks: Aussie investors in the sweet spot

A price revival is helping Australian producers, but there are many factors at play.

Summary: A strong price recovery and beginnings of M&A activity are both having a positive effect on share prices of oil producers. This is further being helped by the Australian dollar, and mid tier miners like Beach Energy and AWE are seeing the biggest short term gains from these factors aligning - though investors might be best to wait and see what the longer term impacts are.

Key take out: Don’t rush back into the oil sector – but be aware of a revival underway.

Key beneficiaries: General investors. Category: Shares.

Oil is back as an investment option. After two years in the sin bin a strong price recovery and the start of takeover activity are indications that the revival could be sustainable.

If there are doubts they lie in the speed of the upturn and whether a higher oil price will trigger a surge in supply, preventing a rise far beyond the current level of almost $US50 a barrel and making it unlikely that there will be a return to the $US100/bbl (and more) enjoyed until mid-2014.

But, for Australian-based oil producers there is a second positive factor at work, the same currency boost being enjoyed by goldminers.

At the latest price for Brent quality oil of $US49.49/bbl, and an exchange rate of US73c, oil in Australian dollars is trading at $A67.79/bbl, well on the way back to its price in mid-2014, a time when the exchange rate was US94c and the local oil price was around $A94/bbl.

The twin benefits of the oil price rising from its mid-January low of around $US27/bbl and the falling currency can be seen most clearly in the share prices of small-to-mid-tier oil and gas stocks such as Beach Energy (BPT) which has almost doubled from 35c on January 21 to latest sales at 65.5c.

The recovery is even more evident in another mid-tier oil and gas producer, AWE, which has risen by 160 per cent since mid-January from 31c to 81c.

AWE’s share price was already recovering when it got a boost from an 80c a share takeover bid launched by a US private equity fund, Lone Star.

More merger and acquisition (M&A) activity is expected in the oil sector with McKinsey & Company, a management consultancy, noting in a report to clients last week that “a deal deluge” typically follows an oil-price collapse.

However the report, titled “Mergers in a low-oil-price environment; proceed with caution” found that deals struck early in the recovery stage of a price crash “haven’t always created value”.

Despite that warning McKinsey said there were signs that M&A activity might be building. “The next M&A wave may be starting to break,” McKinsey said.

Oil-market conditions today are said to be similar to those experienced in the last big oil-price slump between 1998 and 2000, a time when 25 deals of more than $US1 billion each were undertaken in North America alone.

Three of those deals led to the birth of the current crop of super-major oil companies when Exxon acquired Mobil, Chevron merged with Texaco, and BP bought Amoco.

M&A moves in Australia have already seen Woodside (WPL) try but fail to merge with Oil Search (OSH), while Beach has successfully acquired its smaller rival, Drillsearch (DLS).

Santos (STO), a perennial takeover target, has seen significant moves on its share register with Chinese companies ENN Group and Hony Capital swapping at 11.7 per cent stake in the Adelaide-based oil and gas producer.

On the market Santos shares are up 77 per cent from their mid-January low of $2.46 to latest sales at $4.37.

The other leading Australian oil stocks, Woodside and Oil Search, have also risen from their low points, but with less conviction than Santos, Beach of AWE.

Woodside is up 15.6 per cent from $23.82 reached early last month to trade at $27.55 – which is well short of its 12-month high of $36.94. Oil Search is up 25 per cent from $5.56 reached in mid-January to $6.96, short of its 12-month high of $8.36.

It’s in the small-to-mid-tier sector that the effects of the rising oil price, falling dollar, and the start of M&A action, can best be seen with AWE and Beach leading the way, followed by Senex (SXY) which has more than doubled from 11c in mid-January to 27.5c and Sino Gas (SEH) which has risen by 325 per cent since its mid-January low of 2.7c to trade at 11.5c.

Small oil stocks, according to a Macquarie Bank report written earlier this month, are also benefitting from “solid cost control” and an ability to “maintain production rates in a tough environment”.

What comes next will be interesting because the global oil market appears to be adjusting after a massive surge of supply caused by strong US shale-oil output and a refusal of the world’s biggest oil producer, Saudi Arabia, to cut supply.

Goldman Sachs, an investment bank, has been forced to reverse its long-term bearish outlook for oil telling clients in a research note published this week that the oil market has flipped from surplus to deficit.

Forces affecting the market include supply cuts in countries such as Canada (wild fires destroying oil-production facilities), Nigeria (terrorist activity) and Venezuela (social unrest) which have developed just as consumption has been boosted by low prices.

“With each of these shifts significant in magnitude, the oil market has gone from nearing storage saturation to being in deficit much earlier than we expected,” Goldman Sachs said.

However, that positive view of the future oil price came with a qualification. Production outages in Canada and Nigeria will be resolved which could mean that by the end of the year a small surplus might re-develop.

The Goldman Sachs view is that oil will settle in a band of $US45/bbl to $US50/bbl for the rest of 2016, and then rise slowly to around $US60/bbl by the late next year.

For Australian oil producers enjoying US dollar income and Australian dollar costs, that Goldman Sachs price prediction could be another significant positive.

If the Australian dollar is still at US73c towards the end of next year (and some analysts think it will be lower) then at $US60/bbl the local oil price will be $A82/bbl – within sight of the $A94/bbl of two years ago.

No-one is saying rush back into the oil sector, simply note the revival underway and the potential for a sustainable recovery, complete with M&A opportunities.