3 "strong value" oil tips

Iran's return to the global oil market has kept oil prices under pressure of late, and investors are left guessing as to how the politics will play out. But global oil demand is growing at its fastest rate for five years and prices have enjoyed a week-long rally to over $50 a barrel. One City analyst thinks things are on the up.

Dr Dougie Youngson, an analyst at finnCap, reckons the price of Brent will average $65 a barrel in the first half of 2016. That's partly because he believes growing demand will mean most of the oversupply in the market will be mopped up from the second half of next year.

Secondly, with $145 billion being erased from capex budgets this year, production growth has been stuttering. Instability in the Middle East and a continually decreasing US rig count are also good precursors of thing to come.

Fundamentally, OPEC's decision to maintain its production rates in the face of plummeting oil prices - a surprise given historical trends - has worked, argues Youngson. High cost production sources, like US shale oil basins, have been chipped away at and US output is tipped to decline in 2016 from its current plateau.

"Given the 'success' of the market share strategy, it is likely that it will be maintained come the December OPEC meeting," explains Youngson. "Indeed, OPEC is already stating that it feels that the growth in demand against the backdrop of slowing production growth should be sufficient to narrow the supply and demand gap in 2016."

Source: Trading View

Of course, with Iran set to re-enter the export market as early as March next year, investors are understandably nervous about the impact of stalling Chinese growth. If that fails to put enough pressure on supply, excess oil will remain a problem, especially with OPEC refusing to budge. Iran is set to generate 3.8-3.9 million barrels of oil per day, nearly a quarter more than its current production levels.

So, with Iran being the industry's "overhang", Youngson sees two possible outcomes: either Iran re-joins OPEC and current member quotas are adjusted to take the Iran hit, or Iran stays on its own and keeps the market oversupplied.

"Unfortunately we probably won’t get an answer to this until at least the December OPEC meeting, which clearly prolongs the bear market in the oil price," says the analyst. "Our view is that Iran will re-enter the OPEC fold, as it has much to gain following 15 years in the wilderness."

Those watching the collapse of the oil market since summer 2014 are well-versed in the bad news that has dominated the market. But despite all the obvious problems, there has been positive news, too. For example, ENI has discovered 30 trillion cubic feet of gas in Egypt and 43 licences were won in the Irish Atlantic Margin.

For the contrarians wanting to take advantage of negative sentiment, here are Youngson's top tips, all with growing cash flow and balance sheet strength.

"With main board companies down on average 32%, service companies down 1.2% and our basket of AIM stocks down 26% year-to-date, stock selection is crucial. We are therefore confident that there is value to be had in the sector. Investors should be focusing on companies with growing cash flow generation and balance sheet strength as safe(r) bets in what has proven to be a difficult market in 2015."

The analyst picks North Sea oil and gas operator Ithaca Energy (target price 23p implies 249% upside), which also has exploration assets in Norway - the Ithaca operated Greater Stella Area will come onstream mid-2016 at a gross rate of 30,000 barrels of oil equivalent per day (boe/d).

Youngson also likes East African-based up and midstream company Wentworth Resources (target price 63p) -  the gas developer has production assets in Tanzania as well as exploration upside in Mozambique. Third on the list is exploration and production firm Sound Energy (target price 23p), which focuses on Italy Morocco. It's seeking to become a mid-cap company over the next few years, and Youngson points to a strong balanced portfolio in terms of risk and potential upside.

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.