Why I’d Buy Falkland Oil and Gas Limited & Rockhopper Exploration Plc, But Would Avoid Sirius Minerals PLC

As every investor knows, all companies come with potential risks and rewards. That’s the very nature of investing: there is no reward without some risk and, likewise, there should be no risk without a reward.

Of course, while it sounds simple in theory, it can be rather more difficult to put it into practice – especially when it is your own portfolio. That’s because the emotions of fear and greed can take over, causing you to either take less risk and accept a lower reward than you should be doing (due to fear), or take greater risk for a reward that is not as enticing as you realise (due to greed).

Oil Challenges

Clearly, the oil sector falls into the ‘fear’ camp at the present time, with a whole host of industry experts lining up to tell us all why the oil price will definitely not rise to $100 per barrel in the next few years. While they may be right, the track record of oil predictions is not exactly encouraging, with many of these same experts saying just a year ago that oil could hit $150 per barrel. In fact, it sometimes appears as though the done thing when it comes to oil predictions is to simply extrapolate the recent past into the future which, as history tells us, is not particularly insightful when it comes to oil.

Share Price Falls

As such, the oil price could go up, down or sideways in future – nobody really knows. However, the market appears to be pricing in a fall, since the valuations and share prices of a number of oil companies have fallen dramatically in recent months. Take, for example, Rockhopper (LSE: RKH). Its share price is down 15% in the last year but, alongside its partner in the Falkland Island, Falkland Oil & Gas (LSE: FOGL), its shares have been down by as much as 30%+ during the period, as investors have become pessimistic regarding the economics of any potential discoveries.

However, the two companies have seen their share prices rise by 19% and 25% respectively in the last six months, with investor sentiment warming to improved news flow. And, with there being the potential for a major discovery at the Humpback well, as well as the two companies being relatively well financed and having spread the risk via larger partners such as Premier Oil, they appear to offer a favourable risk/reward opportunity.

Share Price Gain

The performance of Falkland Oil & Gas and Rockhopper over the last six months, though, has been dwarfed by the 80% gains posted by Sirius Minerals (LSE: SXX). It operates in an entirely different resources sector, with it seeking to build a potash mine in Yorkshire. And, while investor sentiment is clearly strong, there appears to be an element of greed creeping in, with the market seemingly not pricing in a risk premium.

For example, there is a chance that Sirius Minerals will not gain planning consent to develop its mine. In addition, its financing may not be as straightforward as expected and, although crop studies have yielded positive results thus far, there are no guarantees regarding demand in future. However, these three areas appear to be viewed very positively by the market, with the risk of disappointment not being reflected in Sirius’ share price. As a result, I would avoid buying a slice of it for now, with Falkland Oil & Gas and Rockhopper seemingly presenting a more favourable risk/reward opportunity.

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Peter Stephens has no position in any shares mentioned. 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.