Cheap Oil

By Sham Gad | June 20, 2012 AAA
As the price of oil goes down, so do the prices of many oil company stocks. As is often the case, the bark is worse than the bite. Nervous investors, fearing oil prices will continue to decline, indiscriminately sell oil-related investments, thereby creating an opportunity for patient investors to buy high quality assets at attractive prices.

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Big Oil

Large oil companies are often better insulated to withstand drops in the price of oil. With deeper and more extensive operations, big oil companies often have a lower break-even price per barrel, allowing them to generate profits when others can't. On the plus side, as the price of oil climbs higher, the profits swell quickly. In addition, the generally consistent cash flows accruing from selling oil enable for the payment of attractive dividends, a fact that should be valued highly in today's low interest rate environment.

The world's largest oil company, Exxon Mobil (NYSE:XOM) currently pays a yield of nearly 3% and trades for roughly 10 times earnings. ConocoPhillips (NYSE:COP), which recently spun out, is refining business in order to focus on the more profitable exploration and development part of the oil business, yields nearly 5% and trades for about six times earnings.

Looking overseas, the opportunity is more attractive for patient investors. BP (NYSE:BP), currently trying to settle its liability relating to the Gulf oil spill, yields 5% and trades for over five times earnings. The settlement liability is likely to fall around $20 billion; BP generated over $20 billion in operating cash flow in 2011 alone. The company is not going anywhere and neither is the dividend.

SEE: Why Dividends Matter

Small Oil

Smaller oil companies can be intriguing opportunities as well but investors have to be more acutely aware of the company's businesses, namely its assets and reserve make-up. One such micro-cap worthy of further investigation is Harvest Natural Resources (NYSE:HNR). On the surface, HNR looks very compelling. The company has a market cap of around $208 million, trades for over three times earnings, and has nearly $20 million in net cash on the balance sheet. Harvest holds interests in the Bolivarian Republic of Venezuela; exploration acreage, in Indonesia, Gabon, Oman and China.

As of Dec. 31, 2011, the company, through its 32% interest in Petroleos de Venezuela S.A., had 103.8 million barrels of oil equivalent (BOE) of proved plus probable reserves, including roughly 43 million BOE of proved reserves; and about 60 million BOE of probable reserves. Those 43 million barrels of proved reserves alone are being valued at less than $6 a barrel according the market cap of the company. The company is a very cheap option on successful oil exploration in various parts of the world.

The Bottom Line
Oil's value is without question. Despite a push towards non-oil-based energy sources, oil prices will trend higher in the long run, as finding new reserves will become more expensive. As such, giants like ExxonMobil will continue generating significant profits and delivering dividends to shareholders, while micro-cap plays can offer attractive upside options on successful exploration and development options.

SEE: A Guide To Investing In Oil Markets

At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.

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