The collapse in market confidence is making some junior oils look very cheap.
Recent days have seen stock markets tumble across Europe as concerns and uncertainty mount over what will happen in Greece. As my colleague David Holding noted yesterday, this is making some FTSE 100 shares look distinctly cheap and very attractive.
Oil collapse
What has been less widely reported is that oil prices have been falling steadily, too. Brent Crude has fallen from around $120 barrel in late April to just over $110 per barrel at present. Although it could fall further yet, it is likely to stabilise around $100, thanks to the control exerted over supplies by the Saudis.
Falling oil prices have driven some savage falls in the share prices of junior oil stocks, whose turnover and profit is directly linked to the price of oil. The result of this bloodbath is that some of these companies now look very cheap.
It's worth noting that these falls have not affected the share price of oil majors like Royal Dutch Shell (LSE: RDSB) and BP (LSE: BP) too badly; their size and the proportion of their income that comes from their downstream business (refining and selling oil products) means their profits are less directly correlated to the price of oil.
African energy
Take Afren (LSE: AFR), which has assets in Kurdistan, East Africa and West Africa. Afren published its latest quarterly figures today, highlighting Q1 revenues of $386.7m and a healthy post-tax Q1 profit of $53.2m, thanks to a 327% increase in production compared to Q1 2011.
Oil production is now averaging nearly 42,000 barrels per day and Afren expects to maintain this rate throughout the year, as it intensifies its programme to develop and commercialise its enviable portfolio.
Afren's £1.3bn market cap and proven reserves mean that it is able to access the credit markets for funding and doesn't have to regularly resort to dilutive share issues when it runs short of cash. Despite net debt of $639m, it has $399m cash in the bank and healthy cash flows from its producing assets.
Afren's share price has fallen from a recent peak of 150p a month ago to just over 120p as I write, making it extremely tempting and a definite entry on my shortlist.
What to look for
Although the market falls have affected the whole market, not all falling prices represent bargain buys. Here are the key criteria I would look for when screening oil and gas stocks:
- Market cap between £750m and £2bn.
- Proven reserves and good prospective resources.
- Likelihood of near-term positive developments.
- Existing production assets with good scope for output expansion.
Examples of other companies looking cheap after the recent sell-offs include North Sea exploration and production company Premier Oil (LSE: PMO). Premier has shed more than 10% of its market cap in the last month and currently trades at a 27% discount to net asset value, according to one recent analyst estimate.
Kurdistan pioneer Gulf Keystone Petroleum (LSE: GKP) also looks good, and I like gas-rich BowLeven (LSE: BLV), too.
Have we touched bottom?
It's impossible to know whether we have reached the bottom of this particular crisis. As I write, the markets are having a 'risk on' day, and share prices are recovering slightly from recent falls.
However, I'm pretty certain that there will be more fallout to come. The situation in Greece is not yet resolved, and the latest economic figures from the eurozone show that most European countries are still close to -- or in -- a recession.
The solution to the market bottom risk is to buy into quality companies that fit the criteria I've listed above. That way, you can get a balanced mixture of downside protection and strong growth potential, regardless of short-term market panics.
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Further investment opportunities:
> Roland owns shares in Royal Dutch Shell but does not own any other share mentioned in this article.
