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Profit from the surging oil price

The oil price has been on a tear in the past three months, and our small-cap stock picking expert expects momentum to be maintained

Oil watchers will be keeping a close eye on events in the Middle East following last Friday’s US killing of Iran's top military leader, Qasem Soleimani, in Baghdad, Iraq. It seems inevitable that Iran will launch some form of retaliation against key installations in the UAE and Saudi Arabia, the US’s strongest allies in the region, given that the US is outside Iran’s missile range and any attack on US military bases in the region would undoubtedly result in President Trump sanctioning a retaliatory, not to mention catastrophic, military onslaught. Last autumn’s attacks on Saudi Arabia’s Khurai’s oil field and the country’s largest refinery at Abqaiq highlights how Iran aims to inflict maximum economic damage on pro-US allies.

I would also expect an escalation of tensions in the Strait of Hormuz and Gulf of Oman, the UK government having already taken action to protect UK interests by deploying HMS Montrose and HMS Defender to accompany UK-flagged ships through the Strait of Hormuz, as was the case between July and November following the seizure of a British-flagged tanker by Iran. Not surprisingly, the tinderbox in the Middle East has sent oil prices higher, adding fuel to a three-month long oil price rally that has been driven by a number of other factors, all of which are positive for global oil demand.

Firstly, the US and China are set to sign a phase one agreement in their long running trade dispute on Wednesday 15 January, the impact of which should be a welcome easing of tensions between Washington and Beijing and one that is supportive of a recovery in trade and global economic growth.

Secondly, the People’s Bank of China has just injected Rmb800bn ($115bn) of fresh liquidity into the country’s banking system by cutting the reserve requirement ratio for commercial lenders by 50 basis points, thus lowering banks’ funding costs and freeing up credit for private companies and small businesses.

Thirdly, the recessionary risk that was embedded in equity valuations 12 months ago has been unwinding, helped by the late 2018 volte-face by the US Federal Reserve which subsequently led to the Federal Open Market Committee (FOMC) cutting interest rates three times and reversing its previous monetary tightening cycle. Several other leading central banks have been injecting monetary stimulus into their economies, too.

Fourthly, the landslide victory by the Conservative Party at last month’s General Election means that Brexit will now happen, giving UK business a clearer vision of where the country is heading, while providing the other 27 EU member countries with a major incentive to negotiate a mutually agreeable trade deal in order to avoid crashing out of the UK's goods market and having to trade with the UK – the world's fifth largest economy – on WTO terms.

In the circumstances, it’s hardly surprising that the oil market has been more focused on what could still prove to be a more benign economic road ahead. In fact, Brent Crude and West Texas Intermediate (WTI) have both rallied by 25 per cent to $70.05 and $64.28 a barrel, respectively, from their early October 2019 lows, the US benchmark being buoyed, too, by news of a much higher than expected US weekly crude oil inventory drawdown of 11.5m barrels in the final week of 2019, or more than double that in the previous week, albeit US crude oil inventories of 430m barrels are at their five-year seasonal average.

Interestingly, from a technical perspective, WTI is rapidly closing in on its April 2019 high of $66.60 a barrel, a break-out above this level would open the door to a rally towards the October 2018 high of $76.90. The same is true for Brent Crude which has respective targets of $75.60 (April 2019 high) and $86.74 (October 2018 high).

The momentum in the oil market is of interest to me because I have exposure through three cash rich constituents of my market beating 2017, 2018 and 2019 Bargain Shares Portfolios: North Sea exploration companies Parkmead (PMG:47.4p – ‘Parkmead in bargain basement territory’, 19 November 2019) and Jersey Oil & Gas (JOG:168p – ‘Jersey outlines development prospects’ 19 October 2019); and Chariot Oil & Gas (CHAR:3.1p), an oil explorer with activities in Morocco, Namibia and Brazil (‘Chariot targets farm-out deals, 26 September 2019). I maintain a very positive stance on all three companies in light of the undoubted value on offer in a more buoyant oil price environment and one which improves the economics of commercialising their valuable acreage to support a narrowing of their deep share price discounts to risked net asset value.

I can also see significant share price upside to Trinity Exploration & Production (TRIN:12p), an independent oil and gas exploration and production company focused on Trinidad and Tobago (‘Trinity’s value proposition’, 10 September 2019). The company will be reporting its fourth quarter operational update shortly and analyst James McCormack at house broker Cenkos Securities predicts an exit 2019 production run rate of 3,400 barrels of oil equivalent (bopd), up from 3,017 bopd in October, buoyed by new onshore low-cost wells coming on stream.

But Cenkos is only factoring in an average realised oil price of $57 a barrel in its 2020 revenue estimate of $69m, so with WTI benchmark trading significantly higher and only 41 per cent of Trinity’s third quarter output hedged, then the company has material exposure to the higher spot oil price. Moreover, with Trinity’s net funds backing up a quarter of its market capitalisation of £46m, the shares only trade on a cash-adjusted price/earnings (PE) ratio of 7.5 based on a 2020 net profit of $5.5m even though the risk to 2020 earnings is skewed to the upside. Buy.

 

Promotion ending 10 January 2020. Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased for the promotional price of £12.50 per book plus postage and packing at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 to place an order. The books are being sold through no other source and are normally priced at £16.95 each plus postage and packaging of £3.25 [UK], or £3.95 for purchases of both books.

The books include case studies of Simon Thompson’s market beating Bargain Share Portfolio companies outlining the investment characteristics that made them successful investments. Simon also highlights many other investment approaches and stock screens he uses to identify small-cap companies with investment potential, too. Full details of the content of both books can be viewed on www.ypdbooks.com.

Simon Thompson was named 2019 Small Cap Journalist of the year at the 2019 Small Cap Awards.