QUALIPORT
Is Oil Qualiport Material?

By Maynard Paton (TMFMayn)
August 23, 2001

Carburton Street, London -- Do oil companies make great long-term investments? Ask any long-time shareholder of BP (LSE: BP.) or Shell (LSE: SHEL) and the answer will almost certainly be "Yes!".

According to the CSFB Equity-Gilt Study, both BP and Shell have outperformed the FTSE All-Share index by around 70% since 1965. Okay, so the share price ride may have been bumpy in parts. But the fact that both companies are currently among the six largest on the stock market, as they were thirty-six years ago, does suggest an oil giant has plenty of investment staying power.

A full rundown on the Oil & Gas sector, written by Foolish discussion board regular emptyend, can be seen here. Essentially, the sector can be split into two distinct divisions: the "majors" (i.e. BP and Shell) and the "minors" (i.e. the rest). Are any Qualiport material?

Majors

After a perusal of the accounts and recent results of BP and Shell, I'm admitting defeat. To cut a long story short, I'm dismissing both companies on grounds of financial complexity. One important thing I've learned from my stock market career is:

"You don't have to analyse and invest in complex companies to get great investment returns."

While I've no doubt BP and Shell will continue to do relatively well (they make up 15% of the FTSE 100), I'd only ever envisage investing in either of them as part of a passive, diversified blue-chip portfolio.

Such a passive strategy, of course, can offset any ignorance about each individual stock. In fact, even thinking as a hands-off investor, I can't really see much "value" attraction in the shares at the moment. Leaving aside their complicated earnings, both companies have dividend yields of only around 3% at present.

In general, it's not the Qualiport's style to rely on solely on size and reputation, or to run a traditionally diversified portfolio, to generate an investment return.

Minors

Of the minors, the largest is Enterprise Oil (LSE: ETP), capitalised at £2.9b. Beyond Enterprise, there's a myriad of medium and smaller sized oil players operating throughout various parts of the globe.

For Enterprise and the rest, the key question for long-term investors concerns the predictability of their overall activity. Is oil exploration a predictable business operating with a high degree of certainty? In my opinion, it's not, especially when the drilling takes place in far-flung "exotic" locations.

Of course, you could argue that there'll always be demand for oil. That's true. But there'll always be demand for banking facilities, share trading exchanges, newspapers, television, cigarettes, alcohol and many other products too. These sorts of businesses, I believe, will give fewer operational surprises than any oil explorer.

Another problem with long-term investing in oil explorers (or any other mineral extractor) is that they will always possess a "finite" earnings stream. With a bank, for instance, there's a good chance it'll still provide the same facilities in ten or twenty years time. However, with an oil explorer, it's a certainty that their current oil reserves will run out at some point. Banks, and most other types of company, do not find their products and services "running out". But oil companies must find new wells to survive for the long term.

Summary

However, that's not to say oil companies are bad investments. I've no doubt BP and Shell will remain core blue-chip holdings for many years to come. What's more, most of the smaller oil companies can become attractive to short-term "value" punters too. On that note, relatively low valuations are commonplace in the sector. The future price of oil, at what point will new reserves be discovered, how much will production cost on the new field and so on, all need to be judged when calculating a "fair value" share price. 

So, to sum up then; I'm dismissing the whole sector on grounds of complexity and the inherent unpredictability of exploring for oil. Overall, I'd rather spend my time reviewing more simple, stable and visible business for the Qualiport.

But if I were forced to choose one operator, I'd plump for a short-term punt on Enterprise. As discussion board favourite Hallucigenia points out, the group has the benefit of size and location (Enterprise mainly drills close to home in the North Sea) on its side. But while Enterprise shares may also look cheap, it's all still not enough to persuade me to part with this portfolio's money.

More: Oil & Gas Sector Dissector | Oil & Gas discussion board