Risks Of Oil And Gas Stocks

Foreword from ShareInvestor

This article “Risks Of Oil And Gas Stocks” by Cai HaoXiang was first published in The Business Times on 03 Jun 2013 and is reproduced in this blog in its entirety.

There is a number of business risks associated with oil and gas stocks, particularly explorers and producers.

The first is exploration risk, in that oil explorers might simply be looking for oil wells in the wrong place.
Geological risks exist in that a company’s geological interpretations could be wrong.
There are contract risks, and the risk of a change in the financial stance of a government within the contract.
The two major types of political risk are war and nationalisation. Natural disasters and environmental risks can also affect a business involved in the oil and gas sector. Other risks also not exclusive to oil and gas stocks are corporate risks such as takeovers, commercial risks with the underlying price of the product and labour risks with strikes.
Another way to consider the risks of the oil and gas stocks is from the discovery and development aspect.
This was discussed by oil and gas consultancy RPS at an SGX My Gateway Sector Connect Series earlier in the year. Web clips can be found online.
Essentially, there is a chance that an oil and gas company might not find oil. It might also not be commercially viable to produce the found oil.
In the same SGX series, oil exploration and production consultant Peter Cockcroft shared a number of questions investors should ask before investing in oil and gas stocks: 

  • What does the company do?
  • Where are the company’s assets based?
  • What type of petroleum does the company specialise in? Oil, gas?
  • What is the record of management? Do they have any “skin” in the game? Are they sharing risk with their remuneration package? Does the board have technical knowledge?
  • What is the state of the balance sheet?
  • Are there large investors in the company?
  • What is the oil explorer and producer stock price in relation to their reserves or resources?
  • What are their plans and do they have enough cash to fulfil these plans?
  • Does the company inform the public of activities regularly on their Web page?
  • Is there regular analyst coverage?

Investors can also apply a number of these questions to other types of oil and gas stocks.

Oil Resources Versus Oil Reserves

The Petroleum Resources Management System (PRMS) is a standard report of the reserves and resources of a company involved in oil and gas exploration and production.
A PRMS report can provide a range of estimates for future oil and gas production based on evaluation of reserves and resources of production sharing contracts (PSCs).
On the whole, this is important not just to individual investors, but to other companies involved in the oil and gas industry.
Beyond the exploration and production of oil and gas, there are companies that refine, transport and market oil and gas products. There are also a number of companies that service or equip the explorers and producers with oil rig and ship construction, drilling and engineering.
In clarifying the amounts of resources and reserves, the PRMS uses classifications established by the Society of Petroleum Engineers (SPE), the World Petroleum Council (WPC), the American Association of Petroleum Geologists (AAPG) and the Society of Petroleum Evaluation Engineers (SPEE). The PRMS is compiled by independent qualified persons.
The PRMS will distinguish reserves from resources and assess their respective commerciality.
Simply put, prospective resources can become contingent resources upon discovery, which in turn can become reserves upon development.