Blood bath in small cap oil stocks continues

Brent Crude is currently down around half a dollar to $59.5 compared with $115 in June. The implications for small and mid cap oil shares has been dramatic with their share prices in free fall over recent weeks. With the price of oil so stable for so long at over $100 a barrel, most companies were developing projects on the basis that the price per barrel was unlikely to drop below $80, never mind $60, levels last seen in the depths of the financial crisis of 2009. But OPEC’s actions last month in refusing to cut production have meant that some are even betting that the price could fall as low as $45 a barrel, making many fields uneconomic if that price persisted for any length of time. The impact on some big oil producing countries has been significant, with the Russian Rouble collapsing yesterday to 70 to the dollar at one point despite interest rates rising 6.5% to 17%.  Some like Saudi Arabia who have very low production costs are prepared to wait out the period of low prices as they attempt to destabilise higher cost producers in area such as the Bakken in the US, offshore Brazil, the North Sea and Canadian tar sands.

For many of the favourites of UK investors its been a year to forget.

Kurdistan focused, Gulf Keystone Petroleum, rallied strongly yesterday after confirming that production was on track to hit 40,000 barrels a day their stated target for 2014. But at 57p the shares are well down on recent spikes triggered by the start of payments by the Kurdistan Regional Government and 24% down in the last month. With the giant Shaikan field and a more stable operating environment after the advances of ISIS seem to have been temporarily stopped into the North of Iraq, GKP could benefit from a substantial re-rate if prices recover in 2015. But a very long period of low oil prices could put the company’s finances into focus with some significant debt to service.

Nigeria focused Afren, has had an awful 2014 with the share price collapsing 75% in the last 6 months after revelations that its Chief Executive was taking unauthorised payments and production from its key assets have struggled due to technical problems and weather. With high debt and further drilling news  not expected until mid-2015, investors have taken fright with the share price dropping to 35p. This company has always been a potential takeover target due to its substantial reserve base and at these sort of levels it is not inconceivable that a larger player could pounce.

Falklands focused oil explorer, Rockhopper Exploration, has fallen 29% in the last month to 58.7p despite over $200 million in cash and the start of further drilling in the North Falkland basin due in the second quarter of 2015. With oil prices this low, investors are worried that its partner Premier Oil, who is currently developing the Sea Lion field with RKH, may decide not to proceed with the project at final sanction in mid-2016. Recently the two companies announced a lower cost route for Sea Lion meaning that another farm-in partner would not be needed but with lower production per day and first oil due 2019. At less than 60p, RKH shares are certainly looking interesting with more drilling and the prospect of a reserve increase next year.

The same applies for fellow Falkland oil explorer, Falkland Oil and gas which like Rockhopper will be sharing a rig for wells on its acreage in the North Falkland basis. The shares are down 40% in the last month to 17p with the company reliant on wild cat drilling to find oil having so far failed to find a substantial oil field like Sea Lion after previous drilling activity. But with partners Noble and Edison and its £61 million deal to acquire Desire Petroleum in late 2013, the company appears to be well positioned if sentiment around oil improves and they have some drilling success in 2015. With the company well funded in the short term to find oil, the company’s substantial acreage in the North and Southern basins could produce longer term returns for patient shareholders.

Finally it’s worth mentioning Xcite Energy which has had a very rough 2014 after failing to find a farm in partner for its Bentley North Sea field and having to resort to a partnership with several service companies. At 30p the shares are down 35% in the last month with the low oil price creating worries that first oil from Bentley may never arrive despite the 257 million barrels of 2P reserves.  Shareholders have lost patience as the timetable for first oil has moved back by several years and the key event is now the submission of the Field Development Plan (FDP) to the Department of Energy and Climate Change (DECC) in early 2015. For this to happen, financing for the field needs to be in place and the new environment of low oil prices is worrying some that that Xcite’s partners may get cold feet. But with the scale of the field it seems unlikely that Bentley will be permanently mothballed but clearly the share is not without risk even at these bombed out levels. The management team will need to deliver the FDP and if the company achieves this the shares will be looking very cheap at these levels.

After an awful 2014 for AIM oil shares, 2015 could offer up some opportunities but expect plenty of volatility with some predicting further oil price weakness in the first quarter of next year. Some companies, like those highlighted above, are looking cheap, unless $45 a barrel oil really does become a reality. Here’s to a happy new year for oil stocks!

Contrarian Investor UK

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