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Are Shares In Cairn Energy PLC & 88 Energy Ltd Fully Priced?

2016 has so far been a tough year for the oil sector, but here are two oil stocks that have been defying the general trend.

Up 31% this year

Shares in Cairn Energy (LSE: CNE) are 31% higher since the start of 2016, following positive results from its appraisal well off the coast of Senegal. The company was delighted with the flow rates from its well, which demonstrates the scale of the economically recoverable potential from the Sangomar offshore block.

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The company has great potential in the region, as the anticipated break-even costs are competitive even in today’s low cost oil environment. With a projected total cost of less than $40 per barrel, Sangomar is a highly attractive offshore oil play. On the downside, investors have a long wait before the project returns cash to the company — the first oil will not be produced from Senegal until 2021 at the earliest.

Cairn is in no rush though. Instead, it’s more concerned about building its asset base through an exploration led strategy. Its North Sea developments, Kraken and Catcher, are closer to generating cash, with both projects on schedule to deliver first oil in 2017. Moreover, the company is cash rich, with net cash of $603mn at the end of 2015, which management believes will be enough to cover its capital spending and exploration plans until at least 2017.

Quality assets and a strong balance sheet are clear positives for its stock. But, valuations are expensive relative to the rest of the oil & gas sector, with shares currently trading at a mere 19% discount to its book value. That’s substantially lower than its historical 2-year average discount of 36%, despite oil price benchmarks being significantly higher during much of that period too.

With oil prices today still barely above the projected break-even costs for a majority of its oil reserves, Cairn’s discount to its net asset value seems unappealing. So, unless investor sentiment towards the oil & gas sector begins to turnaround, valuations are likely to face downward pressure in the coming months.

Sweet spot

88 Energy (LSE: 88E), an Australian-based small-cap oil explorer, has had an even stronger run in the first few months of 2016. It’s shares are up 740% year-to-date, after the company announced successful drilling results from its Icewine exploration well in Alaska. It expects a majority of its acreage there to be located in a thermal maturity sweet spot, which means shale formations in the area are favourable for hydraulic fracturing (fracking).

It’s too early to say whether production could become economically viable, with further appraisals needed to confirm its commercialisation prospects. Nevertheless, the results are encouraging and further positive news flow could see the shares re-rated upwards.

However, until the company can prove the economic viability of the project, 88 Energy will remain a risky bet. There’s still a lot of uncertainty surrounding the development, making the stock an extremely speculative play at best.

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Jack Tang 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.