Oil tips and takeover targets for 2016

Industry expert Malcolm Graham-Wood names his favourite oil majors, and tells Interactive Investor who could be taken over and which small-caps will do well this year. I think M&A activity will pick up in 2016. The longer oil prices stay low, the more companies will get a realistic valuation of what their assets are worth, which is when the buyers will come in. At the moment, sellers still feel they'll get more than they deserve for their assets. As there is no hurry, the buyers are happy to wait, which is when the Exxons of the world will pounce. I don't think there will be a great hurry, but I definitely see a pick-up in M&A activity in 2016.

There are one or two companies potentially in line to be taken over next, maybe more if there's a lot of M&A. Pantheon will stand out if they drill one or two of their big prospects this year. The company is for sale in the longer-term, management have said that, but the longer it takes the better for shareholders as I'm sure it will just accrete value over time.

I think Far, which is in Senegal with Conoco and Cairn, will also be taken over this year. They have done extremely well finding their huge discovery and they have other things in their portfolio which they can continue to run. They might cut a deal so it's just the Senegal asset that gets taken away, but I think that acreage is worth significantly more than the whole of its current market capitalisation, so I expect them to be taken over.

Elsewhere, there are one or two others that might be taken over. Victoria Oil and Gas is languishing after getting itself in a good position in Cameroon, moving from drilling to producing and selling. But the price of its shares is too low for the amount it's producing. I would expect someone like BowLeven, who is in the country already to come and take over VOG.

There's one other thing to bear in mind: there is always talk of what's going on with the bigger and more powerful North Sea oil companies, which now aren't as big and as powerful as they used to be.

Most of them have done really well in reducing their costs and trimming their assets. I'm talking about companies like Ithaca, Faroe, Parkmead, EnQuest and Premier. But a lot of people question whether we need five separate companies.

Obviously, Ithaca is the best in terms of their hedging and Faroe has a good tax position. I wouldn't be surprised if shareholders wanted to throw some of these companies together, keeping all the best quality assets and parking some of the others. Keep an eye out: maybe we will see one or two at the centre of some M&A activity in 2016.

Oil share tips for 2016

Which oil major will do best in 2016?

The wild card will be Exxon because it has been watching the recent events unfold and has plenty of cash and muscle to start acquiring things.

They would probably have gone for BG, which is likely one of the reasons Shell went early. If Shell walks away from the deal for whatever reason, Exxon will be in there because its assets are crucial and would fit well. I expect Exxon to make some significant moves this year, at the moment it's difficult to say where it will be, but the company is being really smart.

Rex Tillerson doesn't have a reputation for over-paying and after seeing the "lower for longer" mantra, he's waiting to see what happens. After all, people will be coming to them, not the other way round.

If shareholders approve the deal, Shell's acquisition of BG should go through in February/March. There may be some renegotiation of terms but Shell did put quite a big stock element in the bid, so the actual price has come down quite a lot. Shell might be in a very strong position at the end of this year.

While Chevron might get involved, most of the other majors like BP will be so concerned on saving money for their dividend that they'll cut capex to try and make the budget stand up; they will struggle to be strong in the M&A corporate market. At the moment I think this area will be dominated by Shell and Exxon. At the moment Shell has the yield, but Exxon will prove itself this year.

What small-cap shares should investors buy now?

I expect most investors are keeping their powder dry, trying to find stocks that will outperform the pretty grim market. We managed to find one or two last year, and those that do well will probably be in the same boat.

Take Pantheon, for example, they made a huge discovery in East Texas, which will be worth significantly more than the current share price. If they drill up a couple more wells the value is there. It doesn't matter what the oil price is, they make decent money at $20 a barrel, so Pantheon has to stay there.

We are keen on Sound Oil because it is exposed to gas in Italy, which is onshore and reasonable as prices are still very high. Sound has a good strategy.

You also want to find a couple of areas that might be more interesting, like the Senegal stocks. Cairn, Far and Conoco's appraisal programme could prove up a substantial amount of money, for example.

You also have to pick up on a number of other areas that have changed, for example in Argentina post-election. There are a couple of players out there, for example President Energy and Andes Energia. Oil is priced at $70 a barrel in Argentina, which is where it will stay, so there are some interesting cheap stocks that should buck the trend. You also have Amerisur in Columbia that has a big pipeline coming on stream.

There are stocks around - you just have to be really canny in trying to find them, whether they discover oil, are in gas or have special situations. They are around, you just have to dig about.

What's your top oil and gas trade for 2016?

The trade for next year is when to reverse the short on crude oil and when to start buying the contango in place. There are many stocks around so I don't expect that to change dramatically. It certainly won't happen at the beginning of the year, unless something specific happens.

The other short position is natural gas in North America. We've seen it come below $2 over the last couple of days (at time of filming in December), which is really down to this winter's weather in the States. After the mild winter I would be short natural gas for the time being. People look at stock levels and we've started to draw against them, which is normal for this time of year.

I'd be prepared to be pretty agile in my short. If it looks like there will be a cold spell, the price of natural gas will pick up. You'll want a short you can close pretty quickly.

Will this year be the last for cheap costs?

After the oil price fell dramatically, we've seen costs also fall in a big way: rig prices are down by at least half and seismic is as cheap as I've ever seen it. If costs rise on the back of stronger prices next year, 2016 might certainly be the last year of cheap costs. It's worth bearing in mind that the oil companies with a drilling programme and a bit of money might be able to drill up some prospects.

How Saudi Arabia could kill OPEC in 2016

The outlook for oil markets in 2016 got a whole lot worse after December's OPEC meeting, as the Saudis showed they're absolutely determined to continue the battle for market share.

There are two things here; firstly, they will try and continue this strategy for as long as they can, certainly the first six months of 2016. Secondly, they are going to take out the higher cost producers.

That's interesting, because we thought exposing higher cost producers would mean US shale would be taken out of the equation - but I think it brings forward the possibility of a significant change within OPEC itself, in other words, the potential break-up of OPEC. In US shale there are probably lower-cost producers than half of the OPEC countries. So, the outlook is pretty grim, especially if you're a high-cost OPEC producer like Venezuela.

I'm looking for things to improve a little, but the first half outlook is poor because of the Saudis' domination and Iran's production returning. As soon as sanctions start to be lifted, half a million barrels of Iranian oil will be produced each day, in due course probably a million barrels a day. At the moment, the market couldn't take it.

Where might oil prices end in 2016?

The fundamentals are strongly against any recovery in the oil price in the first half of 2016, notwithstanding any increase in supply from Iran post-sanctions. Demand is still very weak, I'm not expecting to see any increased draw on OPEC above the 1-1.5 million barrels that is built into the system, and that's certainly coming through already. OPEC produces 31.5 million barrels a day (bod). They would have to be producing 30 million bod or below for the oil price to pick up, but I just don't see that happening.

At the end of 2016, people will start to perceive the fundamentals getting a bit tighter as 2017 numbers come through. Although it won't be happening until 2017, people will perceive demand to be picking up at the end of 2016. There is a six month lag, so you have to be six months ahead of the game. I think the end of 2016 is going to be very important, not necessarily on fundamentals, but certainly on perceptions.

How low could it go?

Is Goldman right with forecasts of $20 a barrel? It certainly could go down to $20 a barrel, the only stopper on the oil price would be political movement from Russia, who is the most important player here, not Saudi Arabia.

Saudi Arabia has said they'll cut production if everyone else does, and by everyone they don't mean OPEC. So the bottom line is: who else is going to help? The only countries producing 10 million barrels a day are either Russia or America, and America won't cut - they might do on price because they are being forced out of the market.

If a deal happened between Saudi Arabia and Russia, however, one or two others will probably help out. But I don't think that would happen unless you got below $30 under the circumstances, that's when people would get most worried.

So, there is no specific base on the oil price. Goldman could be right with $20 being the bottom, but there will be a time when the market realises it's gone too far, it always has over the years. Oils are a cyclical commodity and, like everything else, it will pick up.

How long can the Saudis keep a lid on oil prices?

Well, the Saudis can keep a lid on oil prices for a lot longer than most people think, for two reasons.

First of all, they have decided this is a policy they are going to work through and ensure expensive oil comes off the market. Secondly, they have lived with high oil prices long enough to be pretty wealthy.

I've heard they've run through their savings and are borrowing money in international markets; that's only common sense. They are determined to make sure they squeeze higher-cost oil off the market for as long as possible. They are prepared to take the pain.

Where will it all end up?

Tears, tantrums? I think it will end up sorting itself out in the market as it always does. In the meantime, the market was excited at the recent Paris conference by the fact that fossil fuels are on the way out and alternative energy is coming in. And that's coming from a room of 1,000 people using their tablets, phones and laptops charged by power generated by fossil fuels.

Demand for fossil fuels isn't going to change overnight. Americans still drive 2.5 billion miles each month, the Chinese are building 100 airports and they are driving more. Yes, demand is down and because the world wants to use less fossil fuels and it will, but I don't think you can say this is the end of the road for fossil fuel demand, because it is just not the case.

Let's bear that in mind: there is still going to be significant demand for hydrocarbons for the foreseeable future.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.