My Upstream Oil & Gas Rescue Operations

If you have been following my blog in recent months, you would know that I have been blogging about the Oil & Gas (O&G) industry, starting with oil and moving down the industry value chain to Exploration & Production (E&P), Offshore Support Vessel (OSV) and finally ship/rig building sectors. It is time to string everything together to discuss my rescue operations for the upstream O&G stocks that I have carried out since the start of this year. Please note that the rescue operations were formulated before the Brexit referendum and Swiber's application for judicial management. Post-Brexit and post-Swiber, I am not so sure I can pull off these rescue operations.

Oil

As explained in The Demand and Supply for Oil, there is an inflexion point at around USD35, below which the supply for oil becomes elastic and oil price becomes more resistant to further falls. At this level, it is only a matter of time before oil price recovers. Furthermore, unlike companies operating in the O&G industry, oil price will never go down to zero and be bankrupt. Thus, an Exchange Traded Fund (ETF) that tracks oil price is one of the safer investments in the O&G industry. You just have to wait very patiently for the recovery in oil price.

There is only 1 ETF listed on the Singapore Exchange that tracks oil price, but it is not a pure oil play. Besides oil, it also tracks other commodity prices such as gold, industrial metals and grains. The ETF is Lyxor Commodities, which has a 31% exposure to oil price and 6% exposure to gas price. 

Thus, when oil price was languishing around USD30 in end Jan, I bought Lyxor Comm at USD1.55 and brought my average price down to USD2.20.

Exploration & Production Companies

As discussed in The Missing Link Between Oil Price & O&G Profitability, only companies that are involved in oil exploration and production have a direct relationship with oil price. These E&P companies produce and sell oil in the market. Any change in oil price has a direct impact on their profitability. Thus, when oil price recovers, E&P companies will stand to gain.

Nevertheless, there are also significant risks for E&P companies. The exploration part of the business is high-risk and high capex, not unlike buying a lottery ticket. You can never be sure that the oil field purchased will be able to produce sufficient quantity of oil to be commercially viable. When an oil field is found to be commercially viable, the company will then have to spend more money to develop the oil field for commercial production. Given the uncertainty in oil price, spending money to explore and develop oil fields are risky decisions. 

There are a couple of mostly small E&P companies listed on SGX. My picks in this sector were Kris Energy, Interra Resources and Ramba Energy. Each company has its own dynamics and challenges. Ramba Energy has not produced a single drop of oil yet but plans to do so later this year. It also plans to issue a rights issue soon. Interra Resources is on the other end of the spectrum. It is already producing oil, but oil is a depleting resource. Without incurring money to explore and develop new oil fields, its oil production will continue to decline. Kris Energy is the biggest E&P companies listed on SGX. It has a pipeline of both production and exploration oil fields. Unfortunately, it also has SGD330M of outstanding bonds that will mature in 2017 and 2018.

Thus, even though E&P companies will stand to gain from a recovery in oil price, they are not without risks. Linc Energy, for example, has gone into voluntary administration. My investments in these companies are purely speculative and involved only a small amount of money.

Oil Services and OSV Companies

Among the various sectors in the O&G industry, oil services and OSV sectors are probably among the worst hit currently. We have Technics Oil & Gas and Swiber going into judicial management. As explained in The Missing Link Between Oil Price & O&G Profitability, the primary reason they are not doing well is because they rely on oil majors for their business. In their attempt to navigate the deep and prolonged slump in oil price since Jun 2014, oil majors have cut E&P spending budgets, jobs and deferred major projects. In my opinion, even if oil price were to recover to higher levels, oil majors will be very cautious in raising spending budgets to previous levels after going through such a difficult period. For more information on OSV companies, you can refer to Lessons for Investing in OSV Companies from Shipping Trusts.

These are the sectors to avoid for now. My worst O&G stock (MTQ) is from the oil services sector. The average price for MTQ is $1.34 and I have maxed out the position limit for this stock. I can only ignore it for now. The consolation is that its debt/equity ratio is still manageable at 44%. 

Ship/Rig Building Companies

The ship/rig building sector is further downstream of the OSV sector. It is also facing declining business, but as explained in Keppel Corp – A Good Captain Sailing Through Rough Waters, we have not seen the worst in this sector yet, which explains why shipbuilders seem to perform better than oil services and OSV companies for now.

Having said the above, the actions that individual companies take can help to mitigate the impact to some extent. For more information on Keppel Corp's mitigation actions, you can refer to the above-mentioned post and How Will Keppel Corp Navigate the Oil Crash?

Action-wise, at the start of the year, my cost price for Keppel Corp was $6.83. Not only that, I also had the stock in my joint account with my father. When Keppel Corp crashed to below $5 in Jan, I decided to take over the stock in the joint account, which meant I faced double the loss. This left me with no choice but to execute a risky averaging down action which brought my average price down to $6.08. Thankfully, when Keppel Corp recovered to above that price in Mar, I quickly sold 70% of it. I hesitated to sell the remaining 30%, because I knew among all the O&G stocks in my portfolio, Keppel Corp was probably 1 out of only 2 stocks that could save itself and others. When I finally concluded that I should sell all of it, it had already dropped below my average price. Anyway, as explained in Keppel Corp – A Good Captain Sailing Through Rough Waters, keeping it might not be too bad a choice, except that it might probably take 5 years or more to recover.

The other shipbuilding stock in my portfolio is Baker Tech. My original cost price was $1.25 and I averaged down at around $0.875 in Jan and Mar in anticipation of the recovery in oil price. Unfortunately, I forgot that it planned to carry out a share consolidation and most companies that do so end up having lower prices post-consolidation. It does not have much shipbuilding business, so it gave itself an order to build a liftboat. It currently trades at $0.555, but has $0.558 in cash and no debt as at end Jun 2016. Having said that, the cash reserves will continue to drop as construction of the liftboat progresses. Given its large cash reserves, it should be able to survive the harsh O&G winter.

Conclusion

This has been a long post. To summarise my rescue strategy for the upstream O&G stocks, I am relying on oil price to recover. Direct beneficiaries of this will be ETFs that track oil price and E&P companies that sell oil. I am also relying on the market failing to understand The Missing Link Between Oil Price & O&G Profitability, so that all O&G stocks will rise when oil price rises. However, post-Brexit, oil price has retreated back to USD40 from USD50. Post-Swiber, the market has also realised that some O&G companies have significant challenges in surviving the long and harsh winter. Time is running out in these rescue operations.

Just a disclaimer, this post is not a recommendation for anyone to buy or sell the above-mentioned or any O&G stocks. It is a recollection of my actions to rescue the upstream O&G stocks in my portfolio.

See related blog posts:

• The Demand and Supply for Oil
• Understanding Saudi Arabia's Game Plan on Oil Price
• The Missing Link Between Oil Price & O&G Profitability
• The Economics of An Oil Exploration & Production Company
• Lessons for Investing in OSV Companies from Shipping Trusts
• Understanding Shipbuilders' Balance Sheets
• Is Keppel Corp's Provision for Sete Brasil's Orders Adequate?
• How Will Keppel Corp Navigate the Oil Crash?
• Keppel Corp – A Good Captain Sailing Through Rough Waters
• The Type of Debts O&G Companies Have Matters
• What Moving Averages Can Teach Us About O&G Stocks
• My Downstream Oil & Gas Recovery Operations
• My Oil & Gas Fightback