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Spluttering oil shares offer good value

Unsuccessful exploration, geopolitical shocks and poor corporate governance have combined to send share prices in the oil and gas sector into value territory
August 27, 2014

The oil and gas sector is down in the dumps. Despite conflicts in the Middle East and Africa temporarily cutting out four million barrels a day of global oil supply - around the highest since the Gulf War, according to BofA Merrill Lynch - the price of Brent crude oil is down 7 per cent this year. Lower-than-expected global oil consumption and rising US supplies are reportedly to blame.

Still, the Brent oil price has held above $100 a barrel all year, as it has broadly for the past three years. That should be boosting the profits and share prices of London-listed oil and gas companies. Instead, company performance from both an operational and exploration perspective has been pitiful. Worse, share prices are tanking: the Aim oil and gas index is down 18 per cent in the year to date while a selection of larger companies covered by Investec - with market capitalisations over $1bn (£600m) - is off 20 per cent.

If there is a silver lining, it’s that valuations are becoming very attractive. Many companies are now trading at or below the value of their discovered resources, leaving exploration barrels as free upside.

 

Disrupted narratives

You only need to look at a few of the highest-profile explorers and producers to understand why sentiment is so poor.

Tony Hayward’s high-flying Genel Energy (GENL) had to withdraw non-essential staff from certain assets in the Kurdistan region of Iraq earlier this month in light of security fears. For now, Genel's producing fields remain unimpaired, but the threat posed by the IS insurgency will likely continue to weigh on the company’s share price. ExxonMobil, Chevron, Afren (AFR), Gulf Keystone Petroleum (GKP) and other groups are also reported to have evacuated staff from the area.

Frustrating geopolitical developments are also hampering BP (BP.). The oil major is indirectly exposed to Western sanctions imposed on Russia over the Ukraine crisis through its near-20 per cent stake in Russia’s Rosneft, in addition to ongoing litigation linked to 2010's Gulf of Mexico oil spill.

Shares in FTSE 250 constituent Afren, meanwhile, tumbled 30 per cent last month after the Nigeria-focused oil producer suspended its chief executive and chief operating officer. An independent review initiated by the board of directors discovered evidence of "unauthorised payments potentially for the benefit of the CEO and COO". Initial findings from the investigation are expected to be released on Friday when Afren releases its interim results.

Edinburgh-based Cairn Energy (CNE) is suffering from something altogether different. It might have to sell down assets or raise new capital because tax authorities in India are probing the oil explorer about income tax assessments filed in 2007. They have told Cairn not to sell its $1.1bn (£659m) residual stake in former subsidiary Cairn India while discussions are ongoing.

Ophir Energy (OPHR) controls some of the world’s finest frontier acreage but has not been able to farm down its projects in Africa while oil majors focus on cutting costs. So it has instead been left with a big bill following a string of dud exploration wells. It’s a similar story at peer Tullow Oil (TLW), where rising net debt and exploration failures have wiped out the substantial premium at which shares in the former stock market darling used to trade. They now trade marginally above tangible core net asset value (comprising assets in production or development only).