3 things every oil investor must know

Thinking of buying an oil company? Read this first.

| More on:

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Shares in big oil producing companies including Oil Search Limited (ASX: OSH), Santos Limited and Senex Energy Limited (ASX: SXY) have fallen back in the last month.

However before taking advantage of falling share prices there are three things every current or prospective oil investor should know:

1. Oil price volatility has dropped

According to Reuters the volatility in oil futures has fallen to around the lowest levels since the early 1980s. Benchmark Brent crude oil has traded in a range of $5 either side of $110 per barrel since mid-2012.

One of the key reasons is the boom in shale oil production in the U.S. and around the world. This has had a duel effect of reducing fears oil supplies are coming to an end, while spreading the global production. Globally diversified production has reduced the power previously held by OPEC nations and reduced volatility in the same way that a diversified investment portfolio spreads risk and reduces volatility.

2. How much oil do they have?

It’s important to understand how much oil (or gas) a prospective company has so it can be compared to others of the same calibre. ‘Reserves’ represent the amount of commercially recoverable oil and gas a company has, which has three grades:

1P (Proved reserves)

2P (Proved + probable reserves)

3P (Proved + probable + possible reserves)

1P is the most accurate forecast of ‘proven’ reserves, which stand at least a 90% chance of being recovered. 2P is the sum of proven reserves, plus less certain ‘probable’ reserves, while 3P is the sum of proven, probable and ‘possible’.

According to the American Society of Petroleum Engineers (SPE), the best estimate of energy recovery from a project is generally considered to be the 2P figure. This is also the figure to use when comparing companies, for example using the EV/2P (enterprise value (EV) divided 2P reserves) ratio, which identifies companies that are cheap relative to their 2P reserves.

3. How are they funded?

Oil companies can be high margin and cash rich, but it is essential to understand how the company plans to fund its next round of growth projects. Debt can wipe out a company with no existing oil/gas production to sell, but relying on shareholder equity may mean continued capital raisings requiring you to stump up cash.

An ideal structure is a self-funding one, where the company establishes early well production that then funds future growth. This is the model being adopted by Cooper Basin oil producers like Senex Energy and Drillsearch Limited (ASX: DLS).

Foolish takeaway

Understanding the dynamics of volatility, knowing how much energy a company has and working out its capital structure are three key factors to evaluate when picking a winning oil company to deliver you strong future earnings.

Motley Fool contributor Regan Pearson owns shares in Senex Energy Limited.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

asx share price competitions represented by businessmen arm wrestling
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

person reading news on mobile phone
⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »