The Covid 19 pandemic was the kick-off point to a series of geopolitical and economic events that led to a period of massive volatility in global oil prices.  The absolute low point came in mid pandemic April 2020 when the futures pricing of light oil benchmark for West Texas Intermediate (WTI) dipped to about -$37 per barrel (yes, oil contracts traded negative).  2021 saw the steady recovery in oil prices, and by Q4 2021 the average price of WTI was $77.45, up more than 80%, year over year.

The upward trend in global oil pricing continued into 2022 until spiking in June, after Russia’s invasion of Ukraine sparked supply concerns, sending WTI crude oil prices soaring from $90 to above $120 per barrel in just a few weeks.  The following month analysts at JPMorgan Chase warned that if Russia cuts crude oil output in response to G7 sanctions, global oil prices might reach a ‘stratospheric’ $380 per barrel.

More recently, fears of a global recession raised concerns over energy demand and has been a splash of cold water on oil price bulls.  In the U.S., persistent inflation forced the Federal Reserve to aggressively raise interest rates, increasing the likelihood of a recession. At the same time, Russia’s threat to cut off European gas supplies has many economists predicting that Europe will enter a recession this winter. And finally, China’s economy is showing signs of an imminent slowdown.

Investors are now left wondering will oil prices ever settle out, and if so, at what level?

Shoring Up OPEC Production

The trillion-dollar question quickly became, will Organization of Petroleum Exporting Countries (OPEC) cut oil production in support of global oil prices?  The resounding answer was “yes”, with OPEC+ recently announcing that it would cut oil production by two million barrels per day, reflecting its most significant cut since the start of the pandemic. This recent decision is in stark comparison to policy taken in 2015 when OPEC decided it would ‘defend its market share’ and not cut production in the face of decreasing global demand.

The current OPEC+ move could send oil and gas prices sharply higher and comes just ahead of the U.S. midterm elections, making it a politically sensitive move.  U.S. is a net importer of crude oil and the OPEC+ cartel controls about 40% of the global market supply, giving it tremendous influence on international prices. As a result, there’s little the U.S. can do on its own to influence consumer prices.  At a minimum the OPEC+ production cut announcement has put in near term support levels for oil prices through any short-term recession concerns.

President Biden expressed disappointment following the OPEC+ move to cut energy production. With midterm elections coming up, the administration is keen to avoid increasing gasoline prices that could negatively impact satisfaction with the current administration.  Given the lack of investment in upstream oil projects by the global supermajors, Biden is looking for alternative sources for crude oil and preferably closer to home.

Capitalizing on an Energy Rebound

Investors seeking to capitalize on the rebound in energy prices have many options, but a handful could produce more alpha than others. In particular, investors may want to seek out companies with high oil production weighting, robust netbacks, low declines, and strong free cash flows. These opportunities could offer the best long-term appreciation potential.

For example, Saturn Oil & Gas Inc. (TSX-V: SOIL and OTCQX: OILSF) is a pure-play Canadian light oil company with production focused in the province of Saskatchewan. Saturn has amassed a growing portfolio of light oil producing assets, with a deep inventory of approximately 500 booked drilling locations targeting light oil to drive future growth.  Saturn is ideally situated just north of the boarder with the US and all of its oil production is delivered to the US.  Saturn is one of the lowest valued oil and gas producers in Canada, based on 2023 expected cash flows.

Source:  Eight Capital research issued a Buy rating in July 2022 with a C$7.50 per share price target, reflecting a significant premium to the current market price. The price target was backed by an attractive valuation relative to its industry peers. Note 1: EV/DACF = Enterprise Value divided by Debt Adjusted Cash Flow

If oil prices remain at current high levels, the company anticipates robust 2023 cash flow in the range of C$216.3 million to C$230.9 million, which equates to between C$3.63 and C$3.87 per basic share. This compares well to the current trading price in the range of C$2.35 – C$2.75.  Management intends to reinvest half of that cash flow to expand production and the other half to reducing its debt, enabling high levels of production with exceptional netbacks. 

Looking Ahead

OPEC+’s move to cut production could help boost energy prices while encouraging Western governments to look at boosting non-OPEC production. As a result, investors may want to consider companies like Saturn Oil & Gas Inc. (TSX-V: SOIL) given its Canada-based operational footprint and compelling valuation with upside potential.

For more information, visit the company’s website or receive the investor presentation by email by completing the form below.

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