Four oil tips from City broker

It seems unlikely that the current rally in oil prices is sustainable; the fundamentals just do not stack up. The market is still oversupplied, and will remain so for at least a couple more quarters, and although West Texas Intermediate (WTI) hasn't fallen quite as far as some technical analysts had predicted, the chance of another lurch lower is ever-present.

"Prior to the rally, technical analysts suggested a downside target of $38/b, but it wasn’t reached with WTI developing a rebound from the low of $44.45/b," says Westhouse Securities analyst Jamal Orazbayeva. "Currently oil is developing a consolidation and breakout pattern between support near $48 and resistance near $58."

"Calling the bottom is, in a way, a fool's errand and at best is just an educated guess. A more interesting question is do you need to 'call the bottom' to make an investment call on E&P stocks?"

It's widely expected that the oversupply problem is likely to improve during the second half of 2015 as more rigs are temporarily taken out of service and more oil companies cut back production. Demand is likely to pick up in the seasonally colder months in the west.

Source: TradingView

Medium-term forecasts for average oil prices have been scaled back substantially in recent months and $100 a barrel is unlikely without some kind of geopolitical risk escalation or major demand surge.

But $70-$80 mid-to long-term is not unrealistic, says Orazbayeva, who reduced her oil price forecasts for Brent crude in 2015 to $50/b, for 2016 to $70/b, then $80 long-term. And the Westhouse analyst has come up with three criteria to help pick potential winners. They are:

•Build up your position now and have a realistic mid- to long-term (at least next 12-18 months) investment horizon.

•Cherry-pick stocks that are protected in the near term via hedging or have a low cost base, as well as the ones with a healthy balance sheet.

•Choose stories that can deliver upside on current futures curve (i.e. $80/b long term) and have near-term operational catalysts coming up that may transform the story.

Westhouse's top picks

"Three stocks in my coverage tick these boxes, Faroe Petroleum, Genel Energy and Ithaca Energy," says Orazbayeva. "On a more speculative side, I'd also highlight EnQuest."

In its previous report, published last month, Westhouse said Faroe's 2015 campaign is fully funded and kicks off in the first half of this year, although its target price falls from 200p to 135p.

"Ithaca's covenants are much less onerous and with hedging in place, it is well positioned to weather low oil price environment," the broker says, reducing its target to 95p from 170p.

Cash revenues are expected to be paid on a regular basis to Genel this year, reckons Westhouse, and the receivables with the Kurdistan Regional Government (about $230 million at 31 December 2014) to turn to cash flow. The target slips to 1,000p from 1,100p.

And, finally, Enquest which Westhouse now reckons is worth 65p rather than 120p previously. "We think EnQuest is a play on oil price recovery, given that the market has discounted the majority of its P&D base," says the broker, "and while it still has high net debt levels, it also has hedging in place and a material addition to its production profile from mid-2015."

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.