3 small caps to ride oil’s run to US$100 a barrel

The English economist John Maynard Keynes famously said, ‘When the facts change, I change my mind. What do you do, sir?’

Keynes was coming back at a guy having a crack at him after Keynes changed position on something. 

Right now, I’m forced to do the same thing myself.

I called oil shares a ‘trading dead zone’ a few weeks ago.

They don’t look that way today.

The facts are changing right in front of us.

Oil looks odds on to go to US$100 a barrel within the next month, and odds on again to stay there for a while.

Bloomberg reports:

‘Russell Hardy, chief executive of Vitol Group, the world’s largest independent trader, said his firm now expects demand growth of 1.9 million barrels a day this year – that’s more than 30 per cent higher than the current view of the International Energy Agency, which acts as the industry standard.’

This follows on from analysts at Standard Chartered declaring oil demand would hit an all-time high as early as May this year…and keep going.

Supply and demand forecasts are useful, but not overly reliable over time.

Investor positioning is better.

And right now, the market is accumulating long futures contracts for oil.

That’s not all…

Energy analyst PK Verleger points out this week that open interest in June Brent calls with strike prices at or above US$80 are rising.

He suggests this, and other factors, could drive oil to US$110 by the end of the US summer.

We also know that the wider commodity space is lifting. Tin, copper, gold and uranium are all rumbling lately. Global demand looks robust.

Any commodity is high risk, because they’re so volatile and unpredictable. The related shares double this risk again, because of operational issues that can hit at any time.

Beach Energy [ASX: BPT] is a painful example. It got clobbered on Monday because of cost over runs and delays at its Waitsia project.

With risks like these in mind…

Here’s three ideas to think about when it comes to running with the oil bulls from the small cap sector (my speciality)…

1) Karoon Energy [ASX: KAR] is an established producer with a $1.7 billion market cap.

It operates in offshore Brazil and acquired a stake in a Gulf of Mexico project last year with operating costs under US$10 a barrel.

That puts KAR strategically out of range of any further Middle East flare up.

Together, these two geographies give KAR 11-13 million MMboe production for 2024.

Any rise in oil is additional cashflow from their unhedged barrels. They can use that to quickly work off the significant debt they took on for the Gulf of Mexico buy.

KAR is also part of a group drilling two exploration wells this year too. That adds significant exploration upside (and risk) to the stock. They put the geological odds of success at 62%.

In other words, KAR could be in for a big year if all the cards fall their way.

2) Horizon Oil [ASX: HZN] is a smaller oil stock that has a working interest in two oil projects. One operates off the coast of New Zealand and the other China. The operating costs for these two are below US$21 a barrel.

HZN has a small $291 million market cap with US$45 million in net cash at its last account.

Any juicy rise in the oil price can translate into higher cashflow.

This can either be paid out as dividends or used to fund further growth projects.

Horizon recently took a stake in a Northern Territory gas field to diversify its revenue streams.

This also gives HZN an angle into the domestic Aussie energy market which may come under strong supply pressure over the next few years.

3) Bryon Energy [ASX: BYE] is a microcap oil and gas producer that operates in the Gulf of Mexico. Its market cap is only $88 million.

That seems very cheap considering that Byron has 2P reserves of 13 million barrels of oil plus further gas reserves.

It’s an established producer with cashflow that it reinvests for further exploration and drilling.

Byron’s strategy is to drill over old oil projects with modern tools to tap further oil and gas that the original operator left behind.

Byron already has an established list of future prospects. It uses hedging, at least in part, to protect its cashflow and ensure it can meet it debt obligations.

So there you have it. Three small cap ideas to ride oil’s potential run to US$100 a barrel…and possibly higher.

Don’t forget these are some of the most volatile and risky shares on the market.

However, a sustained oil bull market could certainly lift investor interest in oil and gas small cap shares, largely left behind in the recent rally.

And a higher oil price means big cashflows they can put to work or pay out.

For more investment ideas, be sure to subscribe to Fat Tail Daily.

Best wishes,

Callum Newman

Editor, Fat Tail Investment Research