Oil stocks could be heading for a lost decade: here’s what I’d buy

Roland Head suggests two alternative oil plays with attractive upside potential.

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At the end of 2016, everything seemed to be going right for investors in oil stocks. Brent Crude climbed by 25% to $56 per barrel in six weeks and Saudi Arabia organised an OPEC production cut.

Investors clung on in vain during the opening weeks of 2017, but the writing was on the wall. US oil production remained stubbornly high, as did oil storage levels. The US shale sector was revitalised, and any sign of oil price strength was used to justify putting more drilling rigs to work.

Six months on, and it’s clear that the process of rebalancing the oil market could take much longer than expected. Brent crude recently hit a low of $44 and currently trades at just $48 per barrel. Many investors are struggling to find attractive shares to buy in this sector.

Today I’m going to suggest two stocks — one large and one small — which I believe could be profitable and fairly low-risk ways to invest in oil.

A surprise choice

Mining giant BHP Billiton (LSE: BLT) makes most of its money by digging commodities such as coal and iron ore out of the ground. But the group also sold $3.3bn worth of oil and gas during the second half of 2016, generating an underlying operating profit of $360m.

BHP’s exposure to the oil and gas sector has recently attracted the attention of activist hedge fund Elliott Advisors. The US group believes that the firm’s oil and gas assets would be better managed and more profitable if they were spun off into a separate company.

I’ve no way of knowing whether this view is correct, but to be honest, I don’t really care. As a shareholder, I believe that the fact this question has been raised will probably be enough to improve results.

Chief executive Andrew Mackenzie is now under renewed and public pressure to boost the performance of the firm’s petroleum assets, or consider a sale. That pressure is likely to rise when the group’s new chairman, Ken MacKenzie, takes control later this year.

Looking further ahead, BHP’s profits should benefit as and when the oil market does stage a recovery.

In the meantime, BHP has falling debt levels and is paying a well-covered 5% dividend yield. On both points the firm compares favourably to BP and Shell. I remain a buyer.

Too cheap to ignore?

Stocks which trade on a forecast P/E of three are usually best avoided, I think Serica Energy (LSE: SQZ) could be an exception. This £65m exploration and production company is almost unique among its peers. It actually makes a profit.

Last year saw Serica clock up sales of $21.4m and an operating profit of $3.5m. Despite the firm’s North Sea production being shut down for six months, the group ended the year with net cash of $16.6m. This figure had risen to $30.5m by the end of June.

In its most recent update, Serica said that it has “no material expenditure commitments” but is “actively reviewing opportunities”.

Of course, there’s no dividend. Investors must rely on executive chairman Tony Craven Walker to create value with this money. But given Serica’s low valuation, cash pile and operating costs of just $14/barrel, I think this is a risk worth taking. I’d rate Serica as a speculative buy.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of BHP Billiton. The Motley Fool UK has recommended BP and Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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