The oil and gas industry has experienced difficulties in recent years. The price of oil has risen to over US$50 per barrel from its low of US$27 per barrel in January, but it stands at less than half of its all-time high.

Against this backdrop, Woodside Petroleum Limited (ASX: WPL) has fallen by 20% in the last five years. This is a superior performance to oil and gas peers Santos Ltd (ASX: STO) and Origin Energy Ltd (ASX: ORG). They have declined by 70% and 62% respectively. However, in my view Woodside remains a high risk option for investors.

Strategy

Woodside’s acquisition strategy continued with the recent purchase of half of BHP Billiton Limited’s (ASX: BHP) Scarborough area assets. This is a sound strategy in my view since it materially increases Woodside’s resource base and should allow it to maximise value on its Western Australia asset base.

Although it will not enhance earnings in the short run, it provides long term growth potential. In this sense, it is in keeping with Woodside’s strategy of building a diversified development pipeline. In my opinion, this pipeline provides Woodside with a competitive advantage over its sector peers. It has a proven project delivery platform and reduces risk through having long term off-take agreements with major Asian blue-chip energy utilities. They boost project financing during development and provide Woodside with greater financial stability.

Finances

Woodside’s acquisition programme does not put its long term sustainability under pressure. It has a diversified cash flow stream which is less volatile than many oil and gas companies due to its focus on LNG production. Its balance sheet has net debt of US$4.3 billion. This equates to a net debt/EBITDA ratio of 1.9 times and a net debt to equity ratio of 28%.

In my view, Woodside’s debt levels could increase to fund further acquisitions and to invest in project development. This view is supported by Woodside’s free cash flow of US$176 million in the first half of the current financial year. That figure was recorded despite a rise in capital expenditure of 42% versus the comparable period.

Outlook

Continued global economic growth means increased demand for energy. In particular, demand for gas is likely to increase since it has been the second-fastest growing primary energy segment globally behind coal. Gas has half the carbon intensity of coal and should benefit from a global transition towards cleaner energy. Further, gas is a primary component of base-load power generation across Asia. This means that future demand for gas is likely to be relatively consistent.

However, the continued advancement of the US shale gas industry is a key risk to Woodside’s long term outlook. This increases its risk profile alongside its status as a price taker. This means that it lacks a wide economic moat and is a high risk stock in my opinion. Despite the strength of its finances, acquisition strategy and its relatively consistent demand profile, I believe that Woodside is a stock to avoid.

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Motley Fool contributor Robert Stephens has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.