KAR 0.00% $1.45 karoon energy ltd

Karoon is a Favorite

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    Still fuel in tank: one more ride for oil industry small caps

    Small oil stocks can be worth considering. Picture: Getty ImagesSmall oil stocks can be worth considering. Picture: Getty Images

    Investing in renewable energy, batteries and, most recently, uranium companies – which ultimately fuel nuclear energy – has grabbed the majority of investor attention of late.

    On the flip side there are those making money from fossil fuels despite declining usage.

    A key is not to look to the majors, but rather at small-cap niche players in the space, simply because of the structural changes that are occurring.

    Oil is at its highest level since last year. If the current price is exceeded, an earlier price resistance area from July 2018 points to a possible medium-term target of $US75 a barrel.

    Oil could ultimately go much higher than this, but look at the prices of Woodside Petroleum, Oil Search and Santos.

    These stocks haven’t shot the lights out in the past 12 months, although Santos remains in recovery mode after its near death experiences from too much debt.

    Based on fundamentals, the outlook remains very strong, but the key is that the supply side is increasingly constrained. Basically, the main uses for oil is in transport and chemical products. This demand isn’t going away any time soon. Meanwhile it has been shown that power generation can be rapidly switched, at least in part, to renewable sources.

    But when it comes to share prices, investors aren’t looking out too far because there’s no point. Environmentally challenged oil projects are now less likely to get off the ground.

    Oil companies are now subject to renewed scrutiny from institutional investors, finance providers, the media, green movements and governments. The recent election in the US of a Democrat to the presidency has accelerated these trends.

    The contractor Worley recently noted that an increasing number of major oil and gas companies are setting net zero targets and beginning to modify their strategies. Indeed, some are looking to join the ranks of renewable energy providers.

    Oil companies, fearing low oil prices in the long term, are less likely to commit significant capital to new long-life projects that no longer stack up from a valuation perspective.

    Financing organisations such as banks, under pressure from their own shareholders, are now less willing or unable to finance oil projects.

    Further, potentially weaker future oil cashflows risk debt repayments and provide a further reason for financiers to walk away from oil projects or offer terms that are less attractive.

    The bottom line is that you need to be looking at smaller oil and gas companies that are engaged in transformational strategies and/or are in the position of exploiting a niche market, such as the shortage of gas in eastern Australia caused by the massive export of LNG by majors such as Santos, Shell and Origin Energy.

    Here are three to consider:

    Karoon Energy (KAR)

    This is a favourite and has more than doubled in the past 12 months.

    I still like Karoon because its acquisition of the Bauna offshore oilfield in Brazil late last year has transformed the company from an oil and gas explorer to the fifth-largest producer on the ASX.

    The opportunity exists because the stock isn’t priced in the same league as other producers.

    Moreover, these other producers don’t have the same growth potential. Karoon plans to almost double production from initial levels by 2023.

    Vintage Energy (VEN)

    This is a much smaller operation than Karoon and a much higher risk. I would not put it in the quality basket yet, but it is in the transformation phase, from explorer to gas producer and aims to supply eastern Australia.

    First cashflow is expected in the second half of 2021. A key factor is its management/board experience. Reg Nelson, formerly managing director of Beach Energy, is the chairman. CEO Neil Gibbins is the former COO of Beach.

    These guys know Cooper Basin well, as well as other Australian basins, where it has fully funded programs and a sizeable footprint.

    Energy World Corporation (EWC)

    This is also a high-risk proposition, although it is producing and it is profitable. It has several gas projects located in Southeast Asia and Australia.

    The company is extremely complicated to analyse because it’s in the business of power generation as well as LNG production and import. There is also debt financing from a related party.

    It’s got its own gas fields, supplying a power station and it’s also building an LNG plant and LNG import hub. This might be a small cap, but it’s got big complexity.

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