The Oil Search Limited (ASX: OSH) share price has fallen 20% in the past 2 months, making it one of a number of oil-based stocks to see significant falls in the period.
Oil Search's falling share price follows a drop in the crude oil price from US$74 to US$51, over the same period – a whopping 31% decline. The decline in the oil price has been brought about by a mismatch in demand and supply. There are expectations of slowing growth in the world economy, signaling lower demand for oil. Further, there has been a build-up of oil inventories as supply has not yet reduced to meet this lower demand.
With relatively high fixed costs, the share price of oil companies such as Oil Search is directly linked to the price of oil.
Should you invest?
Whilst we may not know where the oil price is heading, we can assess the quality of the company. Oil Search shares currently trade at 30x earnings, which is well above the market average of 16/17x earnings. This could also be seen as high compared to a competitor such as Woodside Petroleum Limited (ASX: WPL), whose shares currently trade at 20x earnings.
That said, Oil Search has great leverage to an improvement in the global oil price. The company's Muruk-2 asset in Papua New Guinea (PNG) and Pikka-C asset in Alaska have strong potential. The company's third-quarter report showed a 39% increase in total production, from 5.4 million barrels in the June quarter to 7.5 million barrels in the September quarter. This was helped by the recommencement of production in PNG, post the earthquake that ceased operations in the fourth quarter of 2017.
Oil Search is a low-cost producer of oil, with a healthy balance sheet. If the oil price continues to slide, the company stands to benefit from the greater pressure that this has on its higher cost competitors, over the long term.
The Organisation of the Petroleum Exporting Countries (OPEC) met in Vienna, Austria last week, to discuss the potential for restraint on the current supply of oil. OPEC and its allies agreed to cut 1.2 million barrels of oil from daily production. This should help to stabilise the oil price for the next few quarters. Investors should take a long-term view on the oil price, before investing in Oil Search shares.
