It used to be referred to as 'black gold' but with the oil price coming crashing back to earth that description no longer appears particularly apt. The rout in the oil price continued overnight with a barrel of Brent oil down US$1.02 to US$49.15.
As if the price declines so far weren't bad enough for oil producers, according to news reports, leading investment bank JP Morgan is forecasting the commodity to continue to fall; the bank has a March target price of US$38 per barrel. JP Morgan thinks this could mark the low point for oil with the bank expecting an average price of US$49 for calendar year 2015.
Beware of catching a falling knife
Leading oil and gas producers on the ASX have fallen heavily in response to the turmoil in global oil markets. In the past six months, Santos Ltd (ASX: STO) has sunk 47.7%, Woodside Petroleum Limited (ASX: WPL) has lost 22.4%, Oil Search Limited (ASX: OSH) has dropped 20.4% and Beach Energy Ltd (ASX: BPT) has plunged 49%.
These are massive declines when you consider the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) is off just 4.1%.
Falls of this magnitude naturally entice value hunters – the problem for investors however is determining fair value. Assuming an investor can get comfortable with the accuracy of published company data for reserves, the next step is applying an average price to those reserves after accounting for extraction costs (all-in-production costs).
This becomes tricky because there is already anecdotal evidence that oil production costs are falling dramatically. This could lead to producers achieving a similar profit margin but then again…
It's apparent that determining the earnings of oil producers is a tough ask at present even if you knew the future average price of a barrel of oil. What's more, it's hard to rely on the forecasts of analysts who follow the energy sector closely as their numbers may need to be revised down.
All this leaves investors in a situation where it's hard to know if oil stocks have overshot on the downside, or whether their prices only reflect current expectations which may still turn out to be too bullish. If this scenario turns out to be the case then another leg down in oil stocks could result.
