oil play risks

Some interesting notes for those who bray for blood when the oil "doesn't" flow. While SSN doesn't feature here the message still applies. GLTA


IF you're looking for a bargain, a search among the discount bins in the oil and gas sector might be an idea.

Picking the right buy is easier said than done, of course, but that the oil and gas sector is the place to be sniffing around seems to be the take-home message in the latest client note from Peter Strachan at StockAnalysis.

It is a top-heavy sector, too. Of the sector's $89.9 billion total market cap, four companies account for $74.8bn. The next 10 big companies take a further $8.8bn out of that total market cap.

Working from the other end, the 60 smallest oilies (43 per cent of the total number) account for just 0.6 per cent of the capitalisation at a combined $530 million.

Sure, there are many on poverty row in the metals sector, too, but oil exploration needs very deep pockets.

There are 75 companies holding less than $5m in cash (excluding geared producers). That may seem plenty to those who focus on gold juniors looking for a small open-cut operation, but $5m doesn't go far in the world of hydrocarbons.

As Strachan points out, with oil and gas you are looking at high capital intensity and high levels of exploration risk, much higher than in mining.

"Mining companies don't go out into the bush and spend $100m to drill one hole to test a target while facing odds of nine to one that they will fail," he says.

But hit the right target and you also hit payback. Mining projects typically aim to recover their capital in four to five years, but AWE (AWE) recouped its $US260m spent at the Tui oilfield in New Zealand within four months.

Strachan has another interesting statistic: many companies trade with an enterprise value of less than $5 a barrel of 2P (proven plus probable) reserves while, on average, companies spend $30 a barrel to find and then develop oil projects.

Thus investors have opportunities to buy stocks below their book value or net present value.

That, says Strachan, demonstrates a market that is either undervalued, expects the price of oil to fall or has a very healthy aversion to the risks involved.

But what to buy? Now we come to Strachan's latest rundown of the sector with a scattering of bouquets and plenty of brickbats. There's room for just a few.

ADX Energy (ADX), with its offshore project between Tunisia and Italy, is seen as undervalued in terms of prospective resource, with solid technical management but "highly speculative, heavy with stale bulls".

Beach Energy (BPT) is described as a top performer with a solid balance sheet, likely to acquire either Cooper Energy (COE) or Senex (SXY). "Buy and hold for $2 target," he advises.

StockAnalysis also has a buy on Buru Energy (BRU) with the note "stock heavily short-sold: buy for a +$5 value target".

Strachan also likes Carnarvon Petroleum (CVN), which last traded at 7.2c with a large gas target north of Port Hedland, making it a spec buy, but he reckons the company's Thai oil output of just over 500 barrels a day "will never make real money".

Naturally, there are plenty of companies listed as "avoid".

Odyssey Energy (ODY) has been "an odyssey for shareholders, more like a horror movie" while Solimar Energy (SGY) is described as a "leaderless, poorly funded California oil player". A share price of 0.2c "correctly values" Odin Energy (ODN).

The note describes Rampart Energy (RTD) as an "under-funded North Slope Alaska hopeful", however, Edwin Bulseco at DJ Carmichael recently put a spec buy tag on the stock. The junior's acreage is surrounded by majors, with Shell, Exxon Mobil, Conoco-Phillips and Chevron drilling away while Spain's Repsol recently announced three discoveries near RTD's ground.

StockAnalysis has a "wait" on Lonestar Resources (LNR), but Simon Andrew at Hartleys has just sent out a buy recommendation. The latter says LNR remains on track to almost double production in six months driven by an aggressive well program on its three properties on the Eagle Ford shale in Texas.

Lonestar, says Andrew, has been opportunistic in acquiring ground in Wilson County and will look to add hectares when leases expire.

Strachan does not mention Cossack Energy (COD), which has backdoor-listed through the former vending-machine outfit PTO Consolidated.

However, analyst Yaroslav Udvoenko of Foyil Securities of Kiev in Ukraine makes his Pure Speculation debut recommending Cossack as a buy with its ground in Ukraine's Carpathian Basin, globally one of the oldest oil and gas provinces (and Ukraine wanting to become less dependent on Russian gas).