“Be greedy when others are fearful”. This is a view held by Warren Buffett, the renowned Oracle of Omaha. This involves buying companies whose intrinsic value is substantially above their share prices because they are on sale due to the markets’ irrationality and panic.
The intrinsic value of a business can be measured according to the future net cash flows it should generate in the future or according to its net profit history. But it is also common to estimate how much an enterprise is really worth by looking at its book value and comparing this figure to the company’s current share price.
An enterprising value investor might purchase an unprofitable company whose book value per share is considerably higher than its share price, especially if there are good recovery perspectives.
This seems to be the case with the offshore drilling sector now that the shale oil boom might go bust sooner or later. The largest oil companies from the FTSE index include BP (LSE:BP) and Royal Dutch Shell (LSE:RDSB). These giants consider shale oil to be one of the most important areas of their business activities. However, these companies are quite diversified and they also invest heavily in offshore drilling. I would like to explain why the latter is highly likely to recover, whereas the shale oil sector is rather risky.
Even though the US shale oil production hit new records in 2019, most oil producers reduced their exploration spending. This means that new oil would not be discovered, whereas old oil fields might plateau very soon. This is a view held by John Hess, an American shale pioneer. His company – Hess Corporation – is involved in exploring the Bakken, but he is going to use the income received from the shale to invest heavily in offshore drilling.
The number of bankruptcies among shale oil producers is rising heavily in the US. Moreover, the slowdown in the US manufacturing activity is partly attributed to decreasing business investments in the Permian.
Both Shell and BP are oil and gas producers with strong presence in the US. Not only is shale oil a key problem for local producers, in many cases gas cannot be sold at reasonable prices. Instead, some local producers have to pay for their gas to be taken because in many areas there is no access to appropriate infrastructure.
Even though BP and Shell might benefit from their smaller competitors’ difficulties, one has to consider the effect that this year’s US presidential election might have on US shale. If a Democrat wins the election, it is quite likely that many companies would lose their drilling permits on federal lands and new ones would not be given.
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Anna Sokolidou does not own any shares of the companies mentioned in this article. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2020