3 Stocks To Buy As Oil Prices Fall: BG Group plc, Gulf Keystone Petroleum Limited and Dragon Oil plc

Yesterday’s decision by OPEC to maintain production at 30 million barrels per day triggered a brutal slump in oil prices: Brent Crude is down to around $72, while its US equivalent, West Texas Intermediate, is trading at about $69.

The biggest casualty is likely to be the US shale market, where some producers are drilling with borrowed money and small profit margins. However, weaker oil prices won’t affect all producers equally. So I’ve selected three London-listed firms that I believe have the potential to do well at lower oil prices.

Dragon Oil (LSE: DGO) shares have only fallen by 3% this week, while most of its peers have fallen by 8-20%.

There’s a good reason for this — oil is very cheap to extract from Dragon’s Turkmenistan oil fields. During the first half of this year, the firm reported a cost of sales of just $20 per barrel, helping it deliver an incredible 68% operating margin.

Dragon also has a $2.4bn cash buffer to protect it against any further downturn, and offers a 5% yield that’s amply covered by free cash flow. It should be a safe home for your money in a stormy market.

BG Group (LSE: BG) (NASDAQOTH: BRGYY.US) is nearing the end of a long period of heavy investment in new projects. The result should be a steady improvement in cash flow over the next couple of years, as the firm’s Queensland LNG project and Brazilian oil fields start to generate cash, rather than absorb it.

A second attraction is that LNG provided 40% of BG’s operating profit during the first nine months of this year. LNG prices are largely unrelated to the oil price, and strong demand means the price of LNG is unlikely to slide like oil has.

Gulf Keystone Petroleum (LSE: GKP) has delivered the solid rise in production it promised this year, and says that rising volumes have cut its cash costs per entitlement barrel produced from $20 to just $9.

Risks remain: although production is continuing as normal, Kurdistan is affected by the ISIS conflict and we have yet to see evidence that the recent agreement between the Kurds and the Iraqi government will translate into more regular payments to oil producers.

However, if Gulf starts to receive regular payments, it should be able to generate positive operating cash flow at current oil prices without much difficulty.

All three of these firms could deliver strong returns, but there's no doubt that the oil market is a risky place to invest, so it's definitely worth looking at other undervalued sectors to diversify your portfolio.

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Roland Head owns shares in Dragon Oil and Gulf Keystone Petroleum. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.