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328 Reasons to sell 88 Energy Ltd, Enquest plc and Cairn Energy plc

Although hopes of an output cut from OPEC may have failed to materialise, investors in the fossil fuel sector have remained buoyed by a steady decline in the US oil rig count in recent months.

A backdrop of low oil prices has encouraged North American producers to steadily scale back their operations, driving the number of producing rigs as low as 316 earlier this month. This is a stark comparison with the record 1,609 units in operation back in October 2014.

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However, Brent’s recent charge back above $50 per barrel has encouraged many US producers to plug their hardware back into the ground.

Indeed, latest Baker Hughes data showed the number of rigs in operation up to 328 in the week to 10 June. This represented the first consecutive weekly rise since last August, and suggests that industry shutdowns in the country may now have bottomed.

Production pains

To me, this bodes extremely ill for the oil price, particularly as the aforementioned OPEC production freeze — as well as that of Russia — appears as far away as ever, the political and economic faultlines across the cartel as pronounced as ever.

Drastic production cuts are required to provide bloated stockpiles with sustained support. Sure, supply disruptions in Nigeria and Canada may have resulted in recent drawdowns. But signs that the US is getting back into gear on the production front are likely to lead to further builds in the months ahead.

Risks outweigh rewards?

News of rising US output is, of course, bad news for the entire oil industry, both for huge operators like BP and Shell as well as fledgling drillers like 88 Energy (LSE: 88E), Cairn Energy (LSE: CNE) and Enquest (LSE: ENQ).

The unpredictability that accompanies oil and gas exploration always makes small producers such as these a bit of a gamble for stock selectors. But when you throw in signs of worsening supply/demand dynamics, their risk profiles rise by a notch or several as economic viability of their operations comes under severe scrutiny.

There’s no doubt that these companies boast some outstanding assets. For example, 88 Energy’s Icewine asset in Alaska has drawn the headlines in recent months as positive testing data continues to emerge.

But the capital-intensive nature of their operations means that Enquest et al desperately need to start generating strong revenues to realise this solid growth potential — indeed, Enquest again touted the possibility of asset sales last month in order to keep its head above water.

Cairn Energy, Enquest and 88 Energy are all expected to keep nursing losses until 2017 at the earliest. And with crude market imbalance looking set to persist, I don’t believe any of these oilies are sound stock picks at present.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has recommended BP and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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