With share prices across the resources sector falling heavily in recent months, there are opportunities to profit in the long run. That’s because, while oil and gas companies are enduring their worst period in many years, their valuations have fallen to such an extent that a number of them now offer sufficiently wide margins of safety to merit investment. In other words, their risk/reward ratios have become rather favourable for less risk-averse investors.
A notable example of this is Africa-focused Tullow Oil (LSE: TLW). Its share price has fallen by an incredible 84% in the last five years and, while it has risen by 23% in the last month, investor sentiment remains very weak. For example, Tullow Oil trades on a price to earnings growth (PEG) ratio of just 0.1, which indicates that its shares offer a very wide margin of safety at the present time.
A potential catalyst to push the company’s share price higher is the planned ramp-up in production which is due to take place in 2016. The company’s TEN field in Ghana is due to come onstream in mid-2016 and increase total production by 35,000 barrels of oil per day (bopd) by the time it reaches plateau production in 2017.
Furthermore, Tullow has refreshed its strategy and is now focused on developing resources which have already been discovered as opposed to concentrating on exploration. This should help to improve the company’s cash flow over the medium term and allow dividends to rise at a brisk pace in future years, as well as providing an improved financial outlook for the business.
Similarly, Falkland Oil & Gas (LSE: FOGL) also has considerable growth potential. Its drilling programme in 2015 has thus far been very successful, with two of the four wells having been drilled and yielded better than expected results. And, while there are currently delays to the drilling programme as a result of a side-track being required, the long term outlook for the company remains relatively bright.
Certainly, Falkland Oil & Gas’ share price has bucked the wider oil sector trend in 2015, with it being down just 3% year-to-date. And, while there is a risk that the oil reserves at the key Humpback prospect are not of a commercial size, the company’s margin of safety appears to be sufficiently wide to merit investment, with it trading on a price to book value (P/B) ratio of just 0.5.
Meanwhile, UK Oil & Gas Investments (LSE: UKOG) has endured a rollercoaster 2015, with its shares rising by as much as 600% since the turn of the year before falling to their current level, which is 200% higher than their 2015 starting point.
A reason for their high degree of volatility could be doubts surrounding the potential for oil production from the company’s eight licence areas in the Weald basin in southern England. Even though US firm Nutech conducted an estimate into the prospect, the market has failed to become particularly excited about UK Oil & Gas in recent months despite the estimate being very positive.
In fact, Nutech’s report states that the gross best estimate oil-in-place over the eight licence areas is 15.7bn barrels of oil, of which around 3.9bn barrels would be attributable to UK Oil & Gas. Of course, there is no current estimate of the recovery rate for the Weald basin and, clearly, the value of any recoverable oil is dependent upon the price of oil. But, for less risk-averse investors seeking out an exploration stock with long term potential, UK Oil & Gas could fit the bill.
