Troubled Oil
PORTFOLIO POINT: Australia’s two big oil companies have had to downgrade their production forecasts, but the future is brighter among the energy juniors. |
Tight global supply and the crisis in the Middle East are conspiring to push the price of oil higher and with it, oil stocks. With analysts predicting that oil could reach $US100 a barrel '” and that it’s unlikely to dip below $US50 until after 2010 '” investors can see plenty of upside to Australian oil stocks. Today we look at the factors driving the price of oil higher and the prospects for locally listed oil stocks.
Over the long term, the concern is focused on demand from China and India. On the supply side, many historically cheap sources of oil are in decline. In Saudi Arabia, for example, there have been no sizeable oil discoveries since 1970.
Leaving aside the complicated issue of “Peak Oil” (the concept that the world will run out of oil supplies) the cost of extracting oil is rising fast. The increasing complexity of projects, rising cost of raw materials and higher taxes on US oil companies are only serving to push the cost of oil per barrel higher.
Oil companies used to have a rule of thumb that the selling price for oil must be roughly three times the cost of finding it. These days, maintaining attractive margins means the formula is increasingly moving towards a multiple of four.
Still, the reality for two of Australia’s largest oil companies, Woodside Petroleum and Santos, is less than rosy.
Woodside has been a favourite with private investors because of its successful track record in exploration and status as the biggest oil producer in the Australian market. Its shares have risen from $16.67 on June 30 2004 to about $44 now.
Despite its strong position as Australia’s leading oil company, it has been widely reported that Woodside will struggle to deliver a promised $1 billion profit. In fact, it is expected to fall several hundred million dollars short.
Last month, Woodside lowered its production forecast from 76 million barrels of oil equivalent to 72 million. Woodside’s share price has risen from $38.90 on December 31, 2005, to $44 on June 30, 2006. This week Woodside was softer, dropping to $43.86.
Santos disappoints
Santos has disappointed shareholders over the past 12 months. More recently, its woes have come courtesy of the acquisition of the Jeruk oil fields in Indonesia. The project was supposed to represent a billion-barrel find for the company, which as recently as July 15 had announced that the find was more in the range of 170 million barrels.
Since then, Santos has announced the purchase of Delhi Petroleum. Unfortunately, the company has neglected to provide much detail about the offer which makes it difficult to judge whether it paid too much.
One company that has delivered to its shareholders over the past two years has been Oil Search. The explorer and producer was trading at $1.30 on June 30, 2004, and exactly two years later was trading for $4.10. In an unusual twist, it is the company’s liquefied natural gas reserves, not oil, that may hold the key to its ongoing success. Initial estimates of its find in Papua New Guinea stand at 370 million barrels of oil equivalent, blowing away concerns about its 2005 profit downgrades.
With a market cap of about $1 billion, Roc Oil has followed an almost identical share price trajectory. On June 30, 2005, it was trading at $1.53; two years later it was $4.23. Its recent acquisition of Apache Oil and the Zhao Dong oil project off the coast of China is a big bonus for the company, but is not without difficulty.
After a disappointing set of results for 2004-05, the Perth based Tap Oil is regrouping. A $10 million share buyback is under way, estimates of recoverable reserves from its Woolybutt field have been revised up by 20% and further good news has come from its recent Aumlet discovery. Analysts expect Tap Oil is unlikely to maintain such a cheap price/earnings multiple in the future.
One of the many bottlenecks in oil production is refinement capacity, which suits a company like Caltex just fine. Asia Pacific, in particular, has a very tight refinement capacity and this is unlikely to be addressed by either China or India in the short to medium term. For investors, the dividend profile has been steadily increasing and represents an attractive yield play. Caltex has gone from strength to strength since hitting recent lows of $16.12 in February, and was trading yesterday for $23.89.
Origin Energy is expected to deliver earning per share growth of 10–15% for 2006-07. After bumbling through a proposed merger with New Zealand’s Contact Energy, cost blowouts in its long awaited Bass Gas project and a possible reduction in margins on its retail business, it represents a high-risk investment.
Two more stocks that are in the game are Hardman Resources and Australian Worldwide Exploration. Neither is making any money and their exposure to risky projects (Hardman’s 19.9% interest in Chinguetti, Australian Worldwide Exploration’s 30% stake in Bass Gas) could make or break the company. Proceed with caution.
The Australian oil sector is well placed to take advantage of a bullish oil industry. The giant oil fields of the past are no longer meeting the demand, under-investment has led to bottlenecks and alternative fuel sources are some time off. But without successful prospects and quick replacements of reserves, some oil stocks will never make the grade as long-term investments.
mAustralia's oil plays | |||
Company | Code |
Price
|
P/E
|
Australian Worldwide Explorers | AWE |
$3.24
|
–46.0
|
Caltex | CTX |
$24.07
|
10.9
|
Hardman Resources | HDR |
$1.82
|
–105
|
Oil Search | OSH |
$4.21
|
17.2
|
Origin Energy | ORG |
$7.52
|
18.8
|
Roc Oil | ROC |
$4.25
|
17.3
|
Santos | STO |
$11.05
|
17.3
|
Tap Oil | TAP |
$2.03
|
14.0
|
Woodside Petroleum | WPL |
$46.50
|
27.5
|