The oil and gas sector is among the most influential of any in the capitalist system as crude oil and natural gas businesses directly or indirectly provide the building blocks for almost every other industry.
Unless you’ve just joined the world from an Amish enclave, it is safe to assume you have an appreciation of crude oil’s continuing place in the world as a source of fuel.
The main components separated at the refinery comprise petrol (or gasoline) which usually accounts for about 44% of a barrel, a group of ‘distillates’ including diesel and kerosene heating oil account for about 19%, and jet fuel represents about 8% of a typical crude barrel.
There are, though, countless other areas beyond fuel that are dependent on hydrocarbons and their derivative products.
A material portion of a barrel of crude is used as crucial petrochemical feedstocks, for example. These petrochemical compounds are used in a variety of processes to create plastics, synthetic rubbers, dyes and synthetic fibres.
They are also used to produce pharmaceuticals, chemical fertilisers, pesticides, insulation, explosives and many other products.
Coming back to fuel, even if a given product doesn’t contain something that originated in a barrel of crude, almost everything else will still likely some degree of dependency upon crude oil.
Naturally, the price of oil is a key focal point for economists and capitalists alike.
A world of demand
Until electric vehicle pioneers such as Tesla Inc (NASDAQ:TSLA) say otherwise, petroleum is inextricable to the global supply chain (though even then Mr Musk will still need rocket fuel if he ever goes to Mars).
Here on Earth there is literally a world of demand for crude and natural gas.
Of course, this is a major factor in the strategic reasoning behind much of today’s - but this is a look at business and investment, not political science nor the environment.
It should be obvious that the petroleum sector is a core part of all investment portfolios, but who are the sector’s main players and which should you be investing in?
First and foremost, you could have a go at trading the commodities themselves. That’s not so easy, however, not unless you have substantial facilities and you’re comfortable getting your hands dirty, literally as well as figuratively.
It is unlikely that very many private investors will have the gumption for physical crude trading.
Most suit and tie oil traders will be prepared to deal in oil futures and an array of other derivative contracts. This is an often volatile market and essentially a 24-market not for those with feint hearts or shallow pockets.
Equity investing offers a more accessible and diverse way to play the petroleum market and globally there are many quite different opportunities to invest.
From taking long-term portfolio holdings of majors BP PLC (LON:BP), Royal Dutch Shell Plc (LON:RDSB), Woodside Petroleum Limited (ASX:WPL) or Santos Ltd (ASX:STO) shares to leveraged CFD trading positions ‘seat of the pants’ exploration stocks, and, everything else in between, there are avenues for most risk appetites.
With the juggernauts investing is all about income and that’s why these companies have fought hard in recent years, including deploying asset sales and cost cutbacks, to maintain dividends against a backdrop of lower oil prices.
2019 saw a turnaround in prices and this had an impact on cash flow generation, which tended to serve the Big Oil stocks well along with their ‘slow-and-steady’ income investors.
London premier market
At the other end of the scale, London is arguably the premier market for smaller oil and gas stocks and is where you’ll find petroleum executives with bright ideas and a need for capital.
London’s investment community is rather robust and knowledgeable when it comes to oil and gas prospecting - and that’s one of the reasons the world’s explorers tend to list there.
The shareholder registers of preferred players most likely comprise a good mix of prestige institutional investors, deep-pocketed hedge funds, private equity and frequently a depth of highly engaged private investors.
The latter group are often the most susceptible to the ambitious and seemingly compelling forward-looking statements that flow out of small cap boardrooms.
Although companies are an awful lot smaller in terms of capital, headcount and operational capacity, ambition and salesmanship are definitely not in short supply.
Put simply, this is the business of finding new hydrocarbon resources and it’s most often done by small companies set-up to risk their very existence in the pursuit of new discoveries.
In rudimentary terms, the idea is to make an educated guess where the oil or gas may exist and then drill a hole to prove it, which is much easier said than done.
Successful explorers reward their investors handsomely. This is a binary business. And, it is not particularly uncommon for a small cap oil speculator to double or even triple their initial capital investments.
At the same time, a well failure can decimate a trading position and, moreover, a bad enough well result can take down a company in its entirety.
Smaller ASX-listed companies have been attracting increased attention during the past 12 months, in particular Carnarvon Petroleum Limited (ASX:CVN), which is in partnership with Santos to develop the Dorado discovery on the North West Shelf, offshore WA.
Other interesting ASX players with diverse involvement in the sector in various global locations are Buru Energy Limited (ASX:BRU), High Peak Royalties Ltd (ASX:HPR), Po Valley Energy Limited (ASX:PVE), Ansila Energy NL (ASX:ANA), FAR Ltd (ASX:FAR), Emperor Energy Ltd (ASX:EMP), Whitebark Energy Ltd (ASX:WBE), Brookside Energy Ltd (ASX:BRK) and Bass Oil Ltd (ASX:BAS).
Typically, these companies are independent and are generally not integrated. Most have a spread of assets including producing fields, field development projects, royalties, proven but undeveloped discoveries and greenfield exploration ventures.
Such companies are valued based on the cash flow they generate and the (risk discounted) barrels that are proven in the ground. Whilst exploration potential very much remains a relevant and attractive factor for investors, it is not what underpins the share price.
Exploration risk is often shared through multi-partnered ventures, and, the negative impact of bad results dissipates more easily because the portfolios already hold material proven assets.
Although it is fair to conclude that small cap exploration isn’t the investment arena for the widows and orphans fund, there are opportunities in this sector and 2020 appears to be an important period for all.