Proactive investors

Time to buy the black stuff?

by Mark Allen

Oil prices have fallen around 15% since OPEC announced plans to cut production by 1.5 million barrels a day at an emergency meeting in October. OPEC will meet again this weekend in Cairo to decide whether to implement further cuts.

As can be seen from the above chart of the FTSE 100 the index found support near the recent intraday low and has subsequently bounced around 14% over recent days.

Some confidence has been injected into equities, with the US Federal Reserve’s (FED) bailout of Citibank, UK Chancellor Darling’s temporary reduction in value added tax (VAT), a rate cut in China and confidence in president elect Obama’s uplifting speech. These are some of the recent global efforts to fend off a prolonged recession.

Technical analysis shows a mixed picture. After posting a fresh short term high in early November, the recent intraday low was above that level reached in October. Therefore, the 3660 level attained in October could have marked the base of a new uptrend, with a series of higher lows and higher highs to follow.

On the other hand, the FTSE is once again approaching the 50-day moving average, which has provided strong resistance over recent months and even if the index can move through this level, the historical resistance and recent high of 4600 could prove hard to break.  

Furthermore, the US markets posted substantial falls last week, with the indices trading new multi year lows. This has deteriorated the longer term outlook for equity markets, as now the lower retracement level has been opened up down to much lower levels.

In conclusion, the next few days will prove critical for equity markets. If the FTSE can push through the two resistance levels mentioned and trade a fresh short term high above 4640, it suggests that the index could have formed a base and is in a new uptrend. However, a failure to break these levels could initiate a move lower and the US indices could drag the FTSE down to new multi year lows.

As a result of the recent rally in equity markets, commodity prices also appear to have stopped falling. After reaching a record of nearly $150 a barrel in July 2008, crude oil prices have fallen to about a third of that within a few months.

The expectation is that the global economic downturn will be longer lasting than initially expected and economic recovery, when it does happen, will be sluggish. This has weighed heavily on oil prices.

Consumer spending in the US slumped to the lowest level in seven years, with gasoline demand falling a further 1.3% last week.

This decline in demand is already reflected in the oil inventories, with US crude oil supplies rising by 7.28 million barrels to 320.8 million barrels last week, which was well above the 1 million rise expected by analysts. This marked the ninth straight increase, which is the longest stretch since April 2005.

OPEC is the organisation of petroleum exporting countries. The 13 countries included provide around 40% of the 86 million barrels of oil the world consumes daily and OPEC’s main role is to set global oil production levels.

Oil prices have fallen around 15% since OPEC announced plans to cut production by 1.5 million barrels a day at an emergency meeting in October, with the fall in demand overriding the reduction in supply. OPEC will meet again this weekend in Cairo to decide whether to implement further production cuts.
 
The average cost to an oil company to drill, dig and deliver a barrel of crude to the market is around $50. Therefore, with oil prices trading around this level, many producers are feeling the pinch.

Furthermore, most OPEC member countries will face real economic problems if crude prices continue to trade at current levels and lower.

Both Iran and Venezuela are dependent on oil prices being nearer $100 a barrel in order to maintain financial stability. The falling oil price is also crippling the Russian economy, to the extent that they may even start co-operating with OPEC on a formal basis.

Consequently, OPEC is likely to cut production by an adequate amount to facilitate a stabilisation in oil prices to around $80 a barrel. Although, OPEC can only control the supply side and the market may still worry that demand could deteriorate further.

The fluctuating oil price is also not only a response to changes in the fundamentals of supply and demand, but the fall has been exaggerated by the fear factor and by speculators predicting prices will move lower.

 

As can be seen from the above chart of oil the sell off has been extremely rapid, with a fall of around 70% in recent months.

Technical analysis of the chart shows that after breaking through the 50 and 200 day moving averages the price has moved sharply lower. However, oil appears to have found temporary support at the previous low of around $50.This level also coincides with the long term trend line that has been in place since November 2001.

The oscillators indicate that oil may have found a base and prices could move higher. The relative strength index (RSI) has moved out of oversold territory and broken above the lower horizontal line, which suggests the buying momentum is escalating and prices could move higher. The moving average convergence divergence (MACD) has also turned and after reaching all time lows the histogram has turned positive and implies a move higher.

With the technicals suggesting oil prices may have found support around $50 and given our earlier discussion of the fundamentals, I believe this could be a good level to start buying oil.

There are a number of ways of gaining an exposure to oil. You can buy shares in major oil producing companies or by buying oil contracts directly in the futures market. However, I favour the crude oil exchange traded commodity (ETC) (epic: CRUD).

An ETC is a leveraged investment vehicle that tracks the performance of an underlying commodity and can be traded in the same way as you would trade an ordinary share.

CRUD is not identical to the oil price quoted on the Nymex or any other exchange. It is designed to track the DJ-AIG crude oil sub-index and offers a useful way of gaining exposure to a longer term improvement in oil prices. CRUD has declined from $87.14 to a low of $29.03 over recent months, which correlates almost identically to the fall in oil.

At the time of writing the price of CRUD is $31.9 and my short term opinion is positive. Near term targets are seen at $33.8, $35.2 and $40, with a stop loss on the trade marginally below the recent low of $28.75.

For investors interested in exposure to oil exploration and production companies, below is a list of small, mid and large cap companies listed on various exchanges and in no particular order.

Ascent Resource (LSE: AST) Since listing in 2004, Ascent Resources has built an extensive portfolio of more than 20 oil and gas projects across six countries in Europe. Ascent's other projects are in Italy, Switzerland, Hungary, Slovenia and the Netherlands. The focus is predominately gas assets onshore continental Europe.

Addax Petroleum (TSX: AXC) has a high quality asset base consisting of a number of producing properties in Nigeria and Gabon, and exploration and development properties and new venture opportunities in West Africa and the Kurdistan Region of Iraq.

BP (LSE: BP, NYSE:BP) is one of the world's largest energy companies, providing its customers with fuel for transportation, energy for heat and light, retail services and petrochemicals products for everyday items.

Canadian Natural Resources (TSX: CNQ) is a mid-tier oil and gas producer with approximately 3,700 employees and production of over 565,000 barrels of oil equivalent per day predominately in North America.

Chevron Corp. (NYSE: CVX) Chevron is one of the world's largest integrated energy companies with operations in more than 100 countries. Chevron is engaged in every aspect of the oil and natural gas industry, including exploration and production, manufacturing, marketing and transportation, chemicals manufacturing and sales, geothermal, and power generation, renewables and advanced technologies.

ConocoPhillips (NYSE: COP) is the third-largest integrated energy company in the United States, based on market capitalization, oil and natural gas reserves.


Devon Energy (NYSE: DVN) is focused primarily in the United States and Canada; however, the company also explores for and produces oil and natural gas in select international areas. Devon also owns natural gas pipelines and treatment facilities in many of our producing areas, making the company one of North America's larger processors of natural gas liquids.

Dragon Oil (LSE: DGO) principal development and production activity is the development of its asset in the Cheleken Contract Area, offshore Turkmenistan. A production sharing agreement was signed with a state agency of the Government of Turkmenistan in May 2000 and has a 25-year term. Dragon Oil had proved and probable oil reserves at 30 June 2008 of 644 million barrels (of which Dragon Oil's share was 283 million barrels) and 3.4 trillion cubic feet of gas resources.

Exxon Mobil Corp. (NYSE: XOM) is the world's largest publicly traded international oil and gas company.

Elixir Petroleum (LSE: ELP) has exploration and production interests in the Gulf of Mexico, UK North Sea and offshore Sierra Leone. Production comes from offshore fields in the Gulf of Mexico, which came into the group after it merged with ASX listed Gawler Resources in 2007.

Empyrean Energy (LSE: EME) has in a very short period of time proven its ability to identify, analyze, negotiate and fund excellent projects with an appropriate mix of risk versus reward. The company’s key interest is a stake in the Sugarloaf and Sugarkane Development Projects in Texas, USA.

EnCana Corp. (TSX: ECA) is a conventional and unconventional oil and gas upstream and downstream company with the bulk of activities in Canada and the United States. EnCana is one of Canada's largest energy groups.
 
Enegi Oil (LSE: ENEG) has operations focused on four prospects around the Port au Port peninsula in western Newfoundland, Canada, which, although lightly explored, is in an active petroleum system with light oil having been discovered on a number of occasions.

Gold Oil (LSE: GOO) is advancing a number of promising oil prospects and discoveries in Peru and Colombia in South America.

Gran Tierra Energy (TSX: GTE) is an international oil and gas exploration and production company headquartered in Calgary, Canada, incorporated and traded in the United States and operating in South America. The Company currently holds interests in producing and prospective properties in Colombia, Argentina and Peru.

Green Dragon Gas (LSE: GDG) is a gas supplier based in China with a focus on the production, development, production, distribution and sales of natural gas from coal bed methane. 

Gulf Keystone Petroleum (LSE:GKP) has exploration and appraisal rights over eight blocks and two producing fields Algeria, and has secured interests in two production sharing contracts in the Kurdistan region of Northern Iraq.

Gulfsands Petroleum (LSE: GPX) has exploration and development projects in the Syrian Arab Republic, Gulf of Mexico, and has signed a Memorandum of Understanding relating to a large project in Iraq.

Irvine Energy (LSE: IVE) is focused on the development of onshore conventional and unconventional oil and gas projects in the USA. The Company currently has exploration and production projects in Kansas and Oklahoma, which it is operating and developing in conjunction with its joint venture partner Metro Energy Group.

Ivanhoe Energy (TSX: IE) is an independent international heavy oil development and production company focused on pursuing long-term growth in its reserves and production. Core operations are in the United States and China, with business development opportunities worldwide.

Marathon Oil (NYSE: MRO) is among the world’s leading integrated energy companies, with substantial interests in the oil and gas upstream and downstream industry, from oil sands in Alberta, Canada, to retail gas stations in North America.

Mediterranean Oil & Gas (LSE: MOG) holds operating rights on a significant number of its assets and has positive, ongoing cash flow derived from production. All of the company’s assets are held in the European Union, principally on and offshore Italy and offshore Malta, except for recently acquired interest in Tunisian permit.

Northern Petroleum (LSE:NOP) is an oil and gas exploration, development and production company focused on the European Union and nearby areas. It is listed on the AIM Market of the London Stock Exchange. The Company is a recognised Operator of both onshore and offshore projects including a producing oilfield and boasts a management and technical team of the highest quality.

Pacific Rubiales (TSX: PEG) is focused on identifying opportunities primarily within the eastern Llanos Basin of Colombia as well as in other areas in Colombia and northern Peru. Pacific Rubiales has a current net production of approximately 21,000 barrels of oil equivalent per day.

Petrel Resources (LSE: PET) operates is in Iraq, where it has been seeking an agreement to develop three existing oil fields in Southern Iraq while applying for exploration acreage in the Western Desert. Petrel have had a presence in Baghdad for years and have successfully built a strong Iraqi and international team and negotiated with the Iraqi Oil Ministry including the first and largest contract awarded since 2003.

Petro-Canada (TSX: PCA) is of Canada’s largest oil and gas companies, operating in both upstream and the downstream sectors of the industry in Canada and internationally.  
Platina Energy (OTCBB: PLTG) has acquired proven producing and proven non-producing reserves in addition to other possible reserves. The Company also owns rights to German inspired oil extraction technology.

Po Valley Energy (ASX: PVE) holds three concession in Italy’s prolific Po Valley Basin which host a 3P gas reserve of 130.4 billion cubic feet (‘bcf’).

Range Resources (LSE: RRL) is both an ASX and AIM exploration Company, with its principal activity directed towards finding and delineating natural resources in the oil, gas and mineral sectors in Puntland, Somalia. Puntland is believed to have all the geological requirements to become a commercial oil-producing region.

Shell (LSE:RDSB) Shell is a global group of energy and petrochemicals companies. With 104,000 employees in more than 110 countries.

Santos (ASX:STO) is a major Australian oil and gas exploration and production company with interests and operations in every major Australian petroleum province and in Indonesia, Papua New Guinea, Vietnam, India, Bangladesh, Kyrgyzstan and Egypt.

Suncor (TSX: SU) has grown to become a major North American energy producer and marketer. Suncor extracts and upgrades oil sands into high-quality refinery-ready crude oil products and diesel fuel. The company also had four wind power projects and operates an ethanol plant.

Talisman Energy (TSX: TLM) has operations in North America, the North Sea, South East Asia and South and Central America.

Woodside Petroleum is Australia's largest quoted oil and gas company, and a leading provider of liquefied natural gas. Based in Perth, Western Australia, Woodside has major operational assets and exploration and development interests in five continents including Australia and the United States.



Mark Allen is Head of derivatives at Simple Investments Stockbrokers. The writer does not hold a position in CRUD. The material in this report has come from Fidessa, Share Scope and CRUD’s corporate website.  

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