As I write, the price of Brent crude oil, the international oil benchmark sits at $82.20 per barrel, a far cry from the $115/bbl reported earlier this year.
Low oil prices are going to cause havoc within the oil sector, as many smaller production and exploration companies rely on a high oil price to fund spending and costly project development. The question is, should you sell up before things get any worse?
Cash rich
Cash rich Ophir Energy (LSE: OPHR) is on a high after selling some of it Tanzanian assets for a total consideration of $1.3bn and the company is now looking for bolt-on acquisitions to boost growth. Salamander Energy is one company in Ophir’s sights and would meet Ophir’s criteria of boosting its international exposure, cash flow and production.
As a cash rich explorer, Ophir is one of the better bets on the oil sector right now. The company can buy up production at rock-bottom prices, laying the foundations to boost long-term growth.
Heading for trouble
Unlike Ophir, Premier Oil (LSE: PMO) is not cash rich and relies upon existing operations, as well as debt to fund capital spending and exploration.
During the first half of the year, Premier’s operating cost was $18.5/bbl, leaving a wide margin between the current price of oil and Premier’s cost of production.
However, these figures don’t include additional items such as depreciation, interest costs and any costs incurred from capital spending and exploration.
After including these extra costs, Premier’s operating margin was only 10.4% during the first half of this year, on an average realised oil price of $109.4/bbl.
Lacking direction
Nevertheless, Premier is in a much better position than producer Afren (LSE: AFR), which appears to be struggling for direction.
Indeed, the company’s third quarter results completely missed consensus expectations, with the company reporting a 35% fall in production as bad weather delayed important work at the group’s key Ebok asset. Profit collapsed by 61% to $166m for the first nine months of the year, compared to the $427m as reported in the year ago period.
Unfortunately, Afren is still lacking a complete management team after firing chief executive, Osman Shahenshah and chief operating officer, Shahid Ullah during October following an investigation into unauthorised payments. It would appear that things are only going from bad to worse for the Africa focused oil explorer.
Set to profit
However, while smaller E&P companies loose out as the price of oil falls, the oil majors like BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) are set to profit.
You see, a large part of BP’s and Shell’s business is refining. These refining operations become more profitable when the oil they use is cheaper.
For example, for every $1 improvement in the profit margin for refined products, BP generates an additional pre-tax operating profit of $500m. This is why the company was able to beat expectations when it reported third quarter results last month.
BP’s underlying replacement cost profit for the period, a figure that includes the replacement cost of supplies, declined 18% to $3.0 billion, although the City was expecting a profit of $2.9bn.
And just like BP, Shell reported an impressive set of third quarter results, which beat expectations. Indeed, during the third quarter Shell’s adjusted net profit climbed 31%, thanks to more profitable new production and improved refining margins.
These results are even more impressive when you include the fact that Shell is possibly the only European oil major that is not aggressively restructuring its operations. So far, the company has only sold $12bn of assets, just under management’s target of $15bn. Meanwhile, BP and France’s Total have sold $50bn and $40bn of assets respectively over the past few years.
The bottom line
So, as the price of oil declines, E&P companies such as Afren and Premier will start to struggle. On the other hand, integrated oil majors such as Shell and BP will be able to ride out the decline as their refining business pick up the slack.
What’s more, even though BP and Shell’s shares are falling, they both offer hefty dividend yields of 5.4% and 5.1% respectively, which could revolutionise your portfolio’s performance.
