A positive outlook for the oil sector

13th February 2017

A positive outlook for the oil sector

A recent column in the FT (David Stevenson – Adventurous Investor, 8th February 2017) commented that one of his “big calls” for 2017 is “an upsurge in corporate activity in the oil and gas space.” He reports that a new investment trust is soon to be listed by Guinness Asset Management that will be focused on investing in small cap oil and gas players – a sector that has been severely restricted in terms of access to capital in recent years. At Buchanan, we are also seeing indications of this new wave of optimism playing out in the market for oil and gas.

Since the 2014 oil price crash, IPO activity in the sector has been sparse. However, it seems momentum is swinging back into the oil and gas IPO market, buoyed by an optimism that the oil and gas commodity prices have stabilised and industry operators have adapted their business models to the $50-55 oil price environment, after enjoying steady prices above $100 per barrel for a number of years.  Already there have been a number of IPOs this year, with Zenith Energy, Eco Oil and Gas and Diversified Gas and Oil (DGO) all coming to market. Despite the fact that these floats are mainly on the smaller side, the implication that the sector is regenerating is supported by a return of generalist institutional investors to these transactions. In recent years, such investors have been underweight and cautious about the sector so their involvement marks a significant change and indicates that a larger pool of capital will be available to new and existing companies in the sector.

This month, Buchanan advised DGO, a US onshore producer, on its $50m fundraise and AIM listing, making it the largest oil and gas flotation in London since 2014. Furthermore, it is the largest US based oil and gas IPO in London since 2008. It attracted generalist blue-chip institutional investors, partly due to its low geological and political risk but also as a result of its attractive dividend policy, something that is extremely rare for small-cap E&Ps. DGO’s investment proposition appealed to investors who have been rightly wary of the sector for a number of years and see DGO as a low-risk vehicle to return to the sector. Nevertheless, the risk appetite of these investors will no doubt increase as the sector’s fortunes improve.

Buchanan anticipates high-risk and high-reward exploration plays will return to favour as investors go in search of those elusive “ten-baggers.”

M&A activity is looking more animated as well. The Shell and BG merger completed in 2016 was anticipated to be a catalyst for sector M&A activity, a prophecy which largely failed to materialise. However, at present shifting priorities for the major players is starting to translate into lucrative opportunities for smaller independents which could lead to a flurry of M&A activity. In the North Sea alone, Shell’s sale of more than half of its North Sea assets to Chrysaor, the recommended offer by Delek for Ithaca Energy and Enquest’s purchase of a 25% in BP’s Magnus Field may be indications of things to come.

Despite the renewed optimism, caution remains regarding the commodity outlook.  There is an expectation that OPEC’s cuts in production may well be negated by the effect of an increase in output of US shale, which could easily cause the market balance to swing back to over-supply.  2016 was a year of recovery for the oil price, having travelled from a low of $27 in February to closing at $55 in December. This made the sector one of the best performing in 2016 (+55%), however, little of these gains were a result of operational success or exciting corporate activity, but rather investor relief that the rebound in prices would enable distressed companies to restructure debt.

The feeling that a rebound in activity is underway is clearly starting to emerge and it is encouraging to see new companies coming through that provide investors with new investment opportunities. If these companies’ stories are well-packaged and deliver on investors’ criteria in terms of quality management, attractive assets, capital discipline and a well-defined growth strategy, then they should perform well.  The continued recovery of companies that survived the downturn and strength of the new companies coming through will help to rebuild overall investor sentiment towards the sector.

Certainly the early indications are that 2017 could be a great year for this sector.

 

For more information please contact Ben Romney, Partner

020 7466 5000