Oil price plays

The bottom has fallen out of the oil price lately. From a December '97 quarter price of over US$23, crude oil prices fell to a low of around US$14 per barrel in March 1998. That's a fall of some 45% and begs a few questions for the companies making money from black gold.

Last week we mentioned how a fluctuating oil price impacted Caltex, but what about those companies that pull oil from the earth as opposed to those that pump it through the bowser?

Why the price of oil has dropped

Firstly an explanation - what has caused this price slump? Basically, there's a fear of oversupply. OPEC member production quotas have increased from 25 to 27.5 million barrels per day. Iraq, after a period in the wilderness, has resumed sales of up to 1.5 million barrels of oil per day. Asia, again, is the source of angst over reduced demand and the effects of El Nino on the northern winter compound the fear.

Are these fears justified? US$14 per barrel seems no more reasonable than US$26 per barrel. Both prices are extreme values that don't adequately reflect the underlying market fundamentals, as the recent rebound to US$16.50 suggests. In the longer term US$14 oil doesn't benefit anybody.

The oil business is hugely capital intensive - you can't just stick a pipe in a hole and hit oil. As a consequence, much of the oil companies profit needs to be reinvested in drilling and new production technology. Low price levels are likely to trigger a reduction in money spent on exploration and development and a curtailment of work done in frontier areas like ultra-deep waters.

It's a situation that nobody wants, especially the members of OPEC whose countries survive on oil revenues. So the fear of oversupply is being addressed. A few weeks ago OPEC made public statements about cutting back production in the hope of pushing the price back up. Will it work? Probably - the oil price should move back into a more realistic trading range of US$18 - US$22 a barrel.

The impact on stocks

So how does all this geo-political shenanigans affect you? Any sustained rise in the price of crude will effect all oil producing companies but the best leverage will come from those stocks strongly sensitive to the oil price. The following is our view on three of the larger companies with such leverage - it's brief but expect more detailed coverage in forthcoming issues.

Woodside Petroleum (WPL) $9.80

The recent price rise from a $9.00 level has been largely oil price driven although until the Laminaria Field commences production in 1999, the company will still be largely driven by domestic gas and LNG sales. For the longer-term investor the stock should be bought around $9.50.

Santos Limited (STO) $5.85

New oil production from Gobe, Elang and Stag developments will boost the stock's sensitivity to the oil price but in a volatile market, the stock should be seen as a defensive, high yield play on the back of strong, domestic gas production. Accumulate the stock at these levels for production and growth.

Oilsearch Limited (OSH) $2.80

With virtually all the company's revenue derived from oil production, any increase in the oil price should fall straight through to the profit line. At $2.80, OSH is worth accumulating for any oil price strength and exposure to highly prospective PNG exploration drilling. If you're looking for an oil play, Oilsearch is the one with most oil price leverage.