Green shoots for Oil and the Energy sector ?
…what the Oil price rise means for Energy Sector small caps
As the global economy emerges into the light after a bruising 2020, and oil and gas prices pick up, energy investors are looking forward to making the most of 2021.
But with much of the Western world still in various states of lockdown, how strong will the recovery be, and what companies are best placed to benefit? We consider the oil and gas sector’s prospects for 2021, and highlight some small caps to look out for.
Companies covered include : #RDSB #BP #DGOC #TXP #DELT #RBD #IOG #WTE #ADME #ENQ
Leaving 2020 behind
The oil and gas sector suffered something of an existential crisis last year, hit harder than almost any other by the pandemic. Brent crude fell from nearly $70 a barrel at the beginning of the year to below $20 in April, with West Texas Intermediate briefly turning negative in the US. The downturn was deepened by a disastrously timed fall-out within OPEC, which prompted Saudi Arabia to increase production just as prices were plunging. Share prices tumbled, with even dividend stalwarts such as BP (BP) and Shell (RDSB) cutting payouts to new base levels.
Signals of the sector’s longer term decline – which might have been more muted during a normal year – were amplified. Denmark, after Brexit now the EU’s largest producer, announced its intention to end all new oil and gas exploration in the North Sea as part of a broader plan to phase out fossil fuel extraction by 2050. The UK set out a plan for accelerating its transition to a greener economy and committed to ending subsidies for the financing of international oil and gas projects. And the steadily falling cost of solar and wind energy highlighted the long-term competitive advantage of renewable power over hydrocarbons: whereas fossil fuel producers must continue to fund new exploration, the marginal cost of wind and solar falls dramatically over time once their infrastructure is in place.
Green shoots
Reading some of the apocalyptic commentary it was easy to forget that oil and gas remains so essential to the world’s energy supply that the industry’s fortunes were sure to rise as the global economy recovered. And tentative green shoots began to appear in the autumn as relatively Covid-free Asean economies began to move through the gears again and massive spending programmes underwrote fragile recoveries in the West.
Confirmation of Joe Biden’s victory in the US Presidential election and a slender Democratic majority in Congress brings the promise of further significant economic stimulus beyond the $900bn package agreed before Christmas. The industry was further boosted by Saudia Arabia’s unexpected decision to voluntarily cut oil supply earlier this month. Oil prices are finally rising again, Brent crude moving beyond $55 per barrel – a 10-month high – and US oil and gas stocks gaining more than a quarter since mid-September, outperforming the S&P 500’s other 10 sectors.
It isn’t clear how strong the recovery will be. A bullish report by Goldman Sachs forecasts Brent rising as high as $65 per barrel by the summer as the US and European economies pick up steam. The bank noted the paradox that the energy transition itself will drive demand for fossil fuels over the coming decade, with commodities from copper to crude required to supply the materials and energy that will be necessary to develop green technologies and infrastructures. And the oil futures curve has strengthened lately, bullish bets taking Brent and gasoline to an 11-month highs.
The International Energy Agency is more cautious, arguing that oil demand will rebound more slowly than initially anticipated this year as Covid persists and the aviation sector in particular continues to struggle. The Agency forecasts global consumption of 96.9m barrels a day this year, up from 91.2m last year but still well below the pre-pandemic record of 100m in 2019. To put that in context oil demand fell by no more than 1m per day in the aftermath of the 2009 crisis.
Wood Mackenzie suggests that 2020 accentuated trends in the energy sector that had been evident prior to the crisis. The increasing challenge fossil fuel producers have in securing capital against competition from the renewables sector means exploration will increasingly be the province of majors and the National Oil Companies (NOCs), which already make three-quarters of discoveries. Investors prepared to commit capital to the industry will expect ever high rates of return, and be less prepared to take risks on small cap explorers. Around 600 to 700 exploration and appraisal wells will be completed in 2021, marginally fewer than 2020 and a 35pc fall compared to pre-pandemic numbers. Larger prospects in proven frontier and emerging plays will represent a higher proportion of a reduced global well count.
But the consultancy considers the exploration industry to be in a better shape now than it was in the wake of the 2014 downturn. Most explorers were already lean going into the pandemic following five years of efficiency savings, and have streamlined their operations even further over the past few months. Despite the challenges there were several drilling successes last year, which added around 15 billion boe of new resources. In the coming 12 to 18 months, many high-impact campaigns are expected, in the highly prospective deep waters off Suriname, Guyana, Brazil, Mexico, the Gulf of Mexico, southern Africa, the Mediterranean, the Black Sea, and elsewhere. Though there might be less speculative exploration the industry can look forward to the realisation of good quality prospects by efficient, disciplined operators.
The Investors’ Chronicle predicts that demand for oil will persist at around 100m barrels a day for at least the next decade: though demand may gradually decline in advanced economies it will continue to be robust in developing countries. But it is unclear whether the established process of juniors exploring in the hope of being taken over will continue. With less capital available smaller caps will have to forge new relationships with larger companies.
With regard to 2021, though demand should continue to gather as economies pick up, it isn’t clear how swift or strong the recovery will be. Continued supply restraint on the part of OPEC is critical, with tensions between members simmering as they weigh renewed lockdowns against a desire to rebuild revenues. A thaw in relations between the US and Iran facilitated by the Biden Presidency could prompt Tehran to offload billions of crude into the market following an ease of sanctions. Ongoing lockdowns across Europe, the UK and the US continue to suffocate demand as restrictions on movement limit the consumption of road fuels and impose severe restrictions on flights, although the impact has been mitigated by demand for heating in cold winter weather.
Small caps to look out for in 2021
But however strongly demand recovers, some small caps are well placed to take advantage. Indeed there were some success stories at mid-cap and junior level even last year, notably Diversified Gas and Oil (LSE:DGOC), whose model of buying mature wells in the Appalachian basin proved resilient, and Touchstone Exploration (LSE:TXP), whose share price soared from 22p at the start of the year to 126p in December on the back of a succession of discoveries. Last month we picked out 10 oil and gas companies to follow in 2021. Here are four more.
Deltic Energy (AIM:DELT) is a good example of a smaller company that has secured a promising arrangement with a major. Deltic, formerly known as Cluff Natural Resources, has interests in five licences in the Southern Gas Basin and two oil prospects in the Central North Sea.
Last year the company partnered with Shell to explore the Gas Basin’s Pensacola and Selene fields. Shell will fund a 3D seismic survey to decide on optimal drilling locations at Pensacola, which has gross P50 resources of 309 BCF, and will meet 75pc of the costs of the first exploration well at Selene, which has P50 resources of 629 BCF. Deltic has 30pc and 50pc working interests in the projects, which will be the the first significant exploration drilling that Shell has done in the Southern North Sea for some years. The company’s other interests include the Cupertino gas field (800 BCF P50 resources) and the Dewar oil field (39.5 MMbbls P50 resources).
Deltic, which recently declined takeover approaches from Reabold Resources and Independent Oil and Gas, has a market cap of £22.1m, its shares having doubled in price to 1.6p since November. The company raised £15m in 2019 to fund its current exploration commitments.
Westmount Energy (AIM:WTE) also has ties with one of the world’s largest oil companies through investments in exploration assets in the prolific Guyana-Suriname Basin. The company has stakes in Guyana-focused exploration company JHI Associates and Eco (Atlantic) Oil and Gas (AIM:ECO), which in turn have interests in two blocks beside the Basin’s highly prospective Stabroek Block, where an ExxonMobil led consortium has discovered some 9bn boe since 2015 (a remarkable 18 discoveries have been made at 20 exploration wells with an average discovery size of 500 MMboe).
JHI Associates has a 17.5pc interest in the ExxonMobil operated Canje Block where three promising exploration wells are planned for 2021 Bulletwood-1, Jabillo-1 and Sapote-1. Last month Westmount announced it had increased its stake in JHI to 7.2pc.
The company’s interest in Eco is focused on the Orinduik Block off the coast of Guyana, in which Eco has a 15pc participating interest alongside partners Tullow Oil and Total. Westmount’s other investments include interests in Ratio Petroleum Energy LP, listed on the Tel Aviv Stock Exchange (RTPT), which has a 25pc stake in the Kaieteur Block, also offshore Guyana, and a 20pc participating interest in Block 47, offshore Suriname.
Westmount, whose share price has risen by a third this year to 21p, taking its market cap to £30m, ended its last year financial year with £557,182 of cash.
ADM Energy (AIM:ADME), is a natural resources investing company with a 9.2pc interest in the Aje field, part of the 835km2 OML 113 licence close to the Benin border.
Five wells have been drilled have so far been drilled at Age, with two still producing. During the first half of 2020, production was 2,126 bopd. The field’s exploration partners are discussing the drilling of three new wells this year with the potential to increase production to 9,000 bopd, 900 of which would be due to ADM. In December ADM increased its stake acquiring 25pc of the interest held by another partner, EER. ADM now has a 9.2pc interest in the field’s profits and net 2P reserves of 16.4 MMboe. Aje’s total gross production in 2020 was 394,812 barrels, with 24,941 net to ADM. The company raised £672,500 in August to fund the deal.
In October ADM reached an agreement with Dubai Bridge Investments, which will fund sub-Saharan projects sourced by ADM. The company also has an MoU for a strategic partnership with commodity trading group Trafigura, to jointly develop and finance approved future acquisitions, including conditional pre-financing of up to $100m with further access to $20m in convertible loan notes. ADM’s share price is currently 6p, and its market cap £6.9m.
EnQuest (ENQ:LSE), formed in 2010 through the combination of the UK North Sea assets of Petrofac and Lundin Petroleum, focuses on a cluster of maturing and undeveloped assets in the North Sea and Malaysia.
The company is moving into 2021 in robust shape, having weathered 2020 reasonably well. A November operations update reported that total production averaged 60,777 boepd in the ten months to end October 2020, just slightly below the mid-point of the 57,000 to 63,000 boepd guidance range. Production was 68,501 in 2019. The company’s Magnus field was the star performer, with average production in the six months to end June at 18,806 boepd, 5.8pc higher than the same period in 2019. Two North Sea fields, however, Heather and Thistle, were victims of the downturn with production suspended indefinitely. Another bright spot was the signing of a sale and purchase agreement with Equinor for an equity interest in the Bressay licenses which adds up to 115 MMbbls to the company’s 2C resources.
EnQuest continues to work to pay off its debt, a hangover from the last oil price crash of 2014, which caught the company at a time when it had committed to extensive capital projects.At the end of October 2020, net debt was $1,388m, an increase of $37m from $1,351m as at 30 June 2020. Revenue was $450.7m for the six months ended 30 June 2020 compared with $858.2m for the same period in 2019.
The company has a strong asset base, with 2C resources of 38 MMbbls and around 250 million barrels of movable oil still to evaluate at Magnus, and an estimated 70 to 130 MMbbls at the Kraken field, both in the North Sea. EnQuest’s share price has spiked up from 10p in November to around 14p, taking its market cap to £237.4m.
