Oil equities – where are we headed?

High price volatility has resulted in oil investors staying on the sidelines, not wanting to buy into their target companies regardless of positive underlying fundamentals.

Absence of buyers at times when some funds and short-term traders need liquidity has depressed share prices, some to levels not seen since the crisis of 2008.

Smaller capitalisation and less liquid shares have been decimated, many of them trading at valuations just above their cash balance. On a market price to cashflow basis, we now see some oil shares trade between one to three times. More importantly, these are companies with growing production, strong balance sheets and highly regarded management that continue to add to the reserves base. Development stage projects seem to be totally disregarded in the present market’s blind quest for safety.

It will not be long before corporate activity by larger, cash-rich but reserve-poor companies accelerates. It is a very rare opportunity to be able to buy a solid company just for its cash and next year’s cashflow, and also get attractive assets with development potential for nothing, yet these opportunities can now be found.

If not, disenchanted management teams may seek to raise necessary financing to make their companies private. If the market is unwilling to rate their projects in relation to the long-term prospects for the oil price, surely it would be worthwhile to avoid the distraction. After all, key Opec members seem determined to keep prices near $100/barrel to finance their growing social programmes in an effort to suppress the threat of the “Arab Spring”. At that oil price, producing companies are making healthy profit margins and development stage projects can have significant value for larger companies seeking to lengthen the life of their reserves.

Despite a difficult year, gold and oil companies, especially small- and mid-sized ones, offer investors promising opportunities moving into 2012.

Angelos Damaskos is chief executive of Sector Investment Managers.