Oil and gas E&Ps will be more robust next year, says Société Générale

Mid cap oil and gas stocks should emerge as more robust value propositions next year, according to French broker Société Générale.

He adds however that investors holding out for another Cove Energy (LON:COV) story, might have to wait until 2013, when he expects M&A activity to pick up again.

Cove has found itself at the centre of a tug of war between two oil majors in Shell (LON:RDSB) and state-owned Thai firm PTT Exploration and Production, but analyst David Mirzai reckons a similar scrap for fellow E&Ps is unlikely this year.

“We think there are industry players now able to potentially offer premiums to market valuations for the assets of smaller players, but extensive consolidation or M&A still looks unlikely for 2012,” he told clients in a note on oil and gas E&Ps today.

This morning, Shell revealed it was extending its bid for the Mozambique-focused explorer to stay in the hunt for its lucrative East African oil and gas assets.

Mirzai remains optimistic on the sector’s outlook however, but marks the lower oil price down as a slight concern.

“A lower oil price environment may stress companies’ balance sheets, causing potential delays to investment decisions vital to bringing new production onstream, and deferral of exploration wells,” the analyst said.

“We think that the quickest route for stock re-rating in this sector relates to the ability to demonstrate success in the exploration phase or to be the subject of M&A interest,” Mirzai added.

“However, we believe that the chances of the former are often overestimated by the market, while predicting the latter is unreliable.”

He believes investors have in recent times favoured stocks with near-term exploration catalysts instead of core value plays that maybe offer better risk/reward than chance of exploration success.

The broker highlights Rockhopper (LON:RKH) as the pick of the bunch, offering some 80 per cent upside potential to his 450 pence target price.

Mirzai even thinks it “may be subject to a pre-emptive bid by one of the early data room participants” as it looks to farm out its acreage by end of the third quarter this year.

He also sees real potential in Premier Oil (LON:PMO), which offers investors “significant value upside” to his core net asset value with free optionality over its exploration programme.

Elsewhere, Tullow Oil’s (LON:TLW) Kenyan results should prove a hit with investors as it confirms its emerging status as a new hydrocarbon basin.

“We continue to believe that results to date in Kenya should be viewed as positive for existing investors that take a longerterm view on Tullow's potential resource base, compared with other European E&Ps, and the pace at which it can test this,” said Mirzai, who has a ‘hold’ stance on the stock as questions linger over how it will spend its considerable war chest.

He also remains on the fence about Cairn Energy (LON:CNE), which he believes is stuck in a “value trap” until it can get rid of its stake in Cairn India to fund development in the North Sea.

Mirzai is adamant that longer-term investors can reap the rewards of the current market discount to the value of Cairn’s core assets, especially given management’s track record of keeping shareholders sweet.

But the main loser in the report is Ophir Energy (LON:OPHR).

The analyst has a ‘sell’ rating on the company, which he says has been riding on the back of Cove’s success given its activity in the area.

While momentum has been building for Ophir so far this year, Mirzai suggests the stock may have hit its peak.

“Ophir may find it difficult to sustain outperformance with a typical exploration drilling programme, which is likely to bring disappointments as well as successes.”

As for juniors, Aminex (LON:AEX), Solo Oil (LON:SOLO) and Wentworth Resources (LON:WRL) will all be keeping a close eye on the M&A activity in East Africa, from which they could benefit if majors continue to stake their claim in the region.