The bargain hunter’s guide to ASX oil shares

Is there any light at the end of the tunnel for oil producers? It’s now two years since prices began plunging in late 2014.

source: NASDAQ

source: NASDAQ

There was some hope that the Organisation of Petroleum Exporting Countries (OPEC) would get together and cap production, but they’ve been talking about it for two years and not much has changed. Even though the US rig count has halved, OPEC has maintained its production, while Russia ramped up its output to take advantage of its hugely devalued Ruble. Now Iran is looking to return to the oil market for the first time in decades as sanctions against it are lifted.

Shares of companies like Woodside Petroleum Limited (ASX: WPL), Oil Search Limited (ASX: OSH) and Santos Ltd (ASX: STO) have been correspondingly hammered, but as yet it seems few producers have gone out of business globally. Indeed both global production and consumption of oil have grown steadily in recent years.

According to figures from the US Energy Information Administration (EIA), global supply and demand are actually pretty closely matched, yet prices remain depressed. After two years, it now appears that the likely way prices will recover is the hard way:

  1. Production declines

Bankruptcies won’t necessarily decrease oil output, as productive assets will be bought up by other companies. Field decline is a real thing though, as many oil producers are using their most productive fields now in order to maximise their cash generation to pay down debt and maintain profitability. That’ll come home to roost, because…

  1. Capex is low

Oil producers have cut their capital expenditure (‘capex’) to the bone, meaning they’re not doing much exploring or drilling. This saves money now, but could go so far as to lead to a gas shortage in 5-10 years, because new wells are not being discovered or exploited.

  1. Increasing demand

Demand for oil has been rising at around 1% per year for the past few years. Too small to be relied on as a primary cause for a re-rating of price, it’ll nevertheless play an important part in repricing oil, especially if production growth starts to slow.

Foolish takeaway

It’s very easy to see how commodities are a cyclical business when you see the relationship between capital expenditure and commodity prices. Higher prices lead to more capital expenditure and thus more production, which perversely leads to oversupply, lower prices, lower capital expenditure, and lower production.

As early investors in the market have discovered to their chagrin, re-rating prices in this manner can take a lot longer than anyone expects. There are some promising signs, but I said that a year ago too.

3 Rotten Shares to Sell, and 1 to Buy Today

After a double-digit rally for the ASX since 2016 lows, investors should be on high alert. You'll find a full rundown below of 3 shares we think you should avoid today plus one top pick worth buying, even if the market turns south and the RBA keeps rates at an "emergency low." Simply click here to uncover these stocks.

Motley Fool contributor Sean O'Neill 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.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.