Where to next for oil prices?
A recent six-year low spooked investors.
The subsequent rebound drew the buyers.
Now, prices are falling again.
Analysts point to a falling rig count as signs that US production will fall sooner or later, normalising prices.
Other analysts say that a falling rig count indicates cost cutting and prioritising of richer wells first, meaning that US production will stay higher for longer.
Yet other analysts point out that the 12-nation Organisation of Petroleum Exporting Countries (OPEC) cartel pumped at more than its 30-million barrel per day target every single day in the past 12 months.
They claim that oil prices will likely rise again once OPEC regains its desired market share.
Major oil and gas companies claim that the world is heading for an oil and gas shortage in the early 2020s as reductions in exploration and development (as part of cost cutting procedures) impact future supply.
How can investors know what to believe?
First off, I think it is safe to say that investors shouldn't expect any joy from the oil market over the short term. Too many factors converge to determine oil prices, including speculation, and investors are at too much of a disadvantage compared to industry insiders.
However over the longer term, I think there's a real opportunity for investors in Australia's larger oil and gas companies.
As contributor Regan Pearson noted in his article here, smaller companies like Senex Energy Ltd (ASX: SXY) can struggle to get funds together to grow their production and reserves during times of low prices and high uncertainty.
Larger companies like Woodside Petroleum Limited (ASX: WPL) and Santos Ltd (ASX: STO) are just entering a period of higher cash flow as a result of major projects being completed recently/ soon and thus don't suffer that problem to the same extent as smaller producers.
Furthermore, Santos and Woodside both have a great portfolio of long-term reserves they can convert into production over time, and the financial leverage to acquire attractive assets as the opportunity arises.
On the face of it, Woodside is the most attractive opportunity thanks to its stronger balance sheet, which minimises the risks of low prices and allows the company to effectively buy growth – which it is doing already.
However, since Woodside shares have remained stubbornly high in the face of lower profits and dividends this year, I don't believe it is the best value right now.
That gong falls to Santos, which has been beaten up recently by a combination of short-selling, low prices, and fears over whether the company can service its debt burden.
(You can find out more on why Santos appears undervalued here)
With the Gladstone LNG plant coming online soon, Santos should experience a sharp rise in cash flow which will allow the company to pay down debt and get its growth plans back on track.
A low share price relative to the rest of the market sees Santos offering more upside than Woodside, although with more debt it also comes with more risk.
Investors are thus left with a choice between the low-risk medium-reward Woodside, or the medium-risk, high-reward Santos. Either way the long-term tailwinds for the oil and gas sector appear positive, and with a weak Australian dollar both companies should remain competitive for a long time.
