Saudi shift could see oil prices, and improving Tullow, on the up
The price of oil has had a difficult year so far in 2017, declining by 20pc since January during the recent sell-off. The recent decision by Opec members to extend production cuts, albeit from very high levels, has dampened sentiment to extremely low levels.
With the commodity entering a bear market, analysts have begun to ratchet down their forecasts and some are going to far as to say oil prices will now move to the range of between $30 and $40 a barrel.
It is very common for analysts covering commodities to get excessively positive towards the peak of a price cycle and as a group, they have a history of panicking towards the bottom end, which is where the price of oil is.
There are several reasons for the oil price to be weak. Firstly, several years of increases in US production, which is now back to peak levels due to shale production, and the resultant global market share gains for the country, have come at the expense of Opec members.
Secondly, there is a global glut of oil products that will take some time to work its way through the system and while oil demand continues to grow, the rate at which shale production has come on stream - despite oil prices of less than half the levels seen during 2010 to 2014 - has taken market participants by surprise.
The negative price oil price environment has resulted in significant declines in share prices for companies in the sector. Several large market capitalisation integrated oil producers such as BP and Shell are down in the region of 10pc year to date, while smaller exploration and production-focused companies have declined by up to 60pc.
There are several reasons to be more optimistic on the outlook for the oil price going forward. There was a subtle change of succession in Saudi Arabia recently, which puts crown prince Mohammed bin Salman first-in-line as heir to the throne. As Opec's most powerful member, the country is the most influential with regards to the outlook for oil.
The Saudi crown prince needs to achieve a higher oil price to successfully float Saudi Aramco - the world's most valuable company - in order to pay for proposed reforms in the country.
Against this backdrop, it makes sense to start kicking tyres, so to speak, and see if there are any companies that offer value, despite a near-term depressed oil price.
One such company is Tullow Oil. A previous darling for Irish and British investors, the stock has declined almost continually since 2012 as the company was caught out having too much debt as the oil price declined while some of its developments have been slower than expected to come online. Management at Tullow has recently undergone a change and there is a new CEO and CFO in place coupled with a deeply discounted rights issue that was completed earlier in the year. With the balance sheet now on a firmer footing coupled with an attractive mix of production assets and higher oil prices hedged in for 2017, the risk/reward case for Tullow is becoming more skewed to the upside.
Furthermore, in a trading statement released last week, Tullow raised its profit guidance for the first six months of the year - which is a positive development. Tullow could start coming up on the radar screens of large oil companies that are looking for potential acquisition targets. With rich acreage positions across both onshore and offshore Africa, Tullow may find itself as a small part of a much bigger company in the future.
David Holohan is chief investment officer with Merrion Capital. Any investment advice given in this column is from the author directly and should not be seen as a recommendation from The Sunday Independent.
Sunday Indo Business