After more than six months of turbulence, it looks as if the price of oil has now stabilised.
Indeed, after falling below $50 per barrel in January, the price of Brent crude has pushed steadily higher over the past three months.
Broadly speaking, this is good news for the oil industry. Even though the price of oil remains depressed, it has stopped falling. Great news for companies like Tullow Oil (LSE: TLW), Premier Oil (LSE: PMO), Enquest (LSE: ENQ) and Ophir (LSE: OPHR), which are now able to forecast future cash flows with more confidence than they could just a few weeks ago.
Don’t jump in
However, while the oil sector’s outlook has improved, investors need to be careful when hunting for bargains.
For example, even though Tullow’s share price has fallen by more than 50% over the past 12 months, according to City figures, the company still trades at a premium to many of its peers.
Tullow’s market value implies a valuation of $22/bbl for the company’s proven and probable reserves, far above the sector’s average valuation of $15 to $17/bbl.
Uncertain times
Meanwhile, Enquest is facing a number of headwinds that could threaten the group’s survival.
Earlier this year, the group had to renegotiate its banking covenants and is relying on cost cuts to boost group margins. Enquest is looking to reduce the average operating cost per barrel produced from $42 to $38 this year. But as the company is already asking lenders for more flexibility on its banking facilities, it seems as if Enquest is running out of time.
The company needs the price of oil to return to the highs seen during 2014 in order to pay down debt and fully finance capital spending.
Overall, Enquest is planning to spend $600m on capital investment this year, and until the Kraken field development starts up during 2017, Enquest could struggle.
City analysts expect Enquest to report a small pre-tax profit of £17m this year followed by a loss of £9m during 2016.
A great relief
Premier Oil’s Sea Lion project in the Falklands is only commercially viable with oil trading above $50/bbl. So, the rising oil price will be a welcome relief for Premier’s management.
That being said, Premier is currently trading at a premium valuation of nearly 45 times forward earnings. This valuation leaves plenty of room for disappointment if the company fails to meet City forecasts.
The best pick
After buying small-cap oil producer Salamander Energy last year in an all-stock transaction, Ophir Energy is one of the best bets on the oil sector.
The acquisition of Salamander’s operations will give Ophir a much-needed cash flow to support its exploration program. Ophir has a world-class portfolio of exploration assets that could yield terrific results for the company.
Moreover, the company reported a solid cash balance of $1.2bn at the end of last year.
Foolish summary
All in all, while the oil market has stabilised, oil producers aren’t out of the just yet. Investors need to be careful which companies they pick to ride the recovery.
