'Junior' oil stocks are undervalued, says Damaskos

Shares in smaller oil producers are undervalued, trading at prices that would be more appropriate if the oil price was 25% lower than today, according to Angelos Damaskos, manager of the Junior Oils fund.

Damaskos, whose fund shot up nearly 10% last week as stock markets rallied, believes the valuations of 'junior oil' stocks would make sense if oil was selling for $75-$80 per barrel, rather than the current $95-$100 (WTI).

Damaskos’ fund has returned 27% over the last 12 months despite suffering losses since February (see chart). The latest recovery came as markets rallied as investors gained confidence that a Greek default could be avoided. In the run-up, Damaskos acted on a belief that smaller oil companies were oversold: ‘When investors get in a ‘risk-off’ [cautious] mode they tend to sell small caps so the whole spectrum was oversold and we bought a lot more stock, in both new and existing companies.’

Damaskos said: ‘The other element in the change of stance was that we felt the oil price went significantly above where it should have been – higher than what the economy can sustain.’

However, he said that circumstances changed when Opec failed to push through production increases, prompting the International Energy Agency to release some of its reserves. ‘The action of Opec showed us there was strong interest in keeping it (the oil price) around $100. We think it will fluctuate between $95-$100 per barrel, that’s the range for the next six to 12 months.’

If this proves correct he said: ‘At this rate the producing companies are making very attractive rates that justify much higher prices. We believe that equities discount a much lower oil price of $75-$80 so there is a considerable re rating if you were to include a $90-$95 oil price.’

Companies in the fund’s top ten holdings like Premier Oil (PMO.L) have seen their value fall while the price of oil has risen. In the first six months of 2011 the price of oil has risen by 16% while Premier Oil has fallen by 8.4% and the Junior Oils fund is down 15%.

Source: Hindsight

Damaskos said the problem had not affected oil companies across the board. The FTSE All Share oil and gas index showed a 4% gain over the first six months of 2011 while Shell was up nearly 8%.

Damaskos said that he was confident smaller company momentum but warned: ‘It’s early days. We still have a lot of problems ahead of us. No one knows how the eurozone debt crisis will be resolved and there are big uncertainties about the global economic picture and investors are still very cautious and worry about the market.’

Many fund managers are exploiting the high oil price in their funds. Two examples from Citywire Selection, our list of investment recommendations, include Jupiter Merlin Balanced Portfolio, run by John Chatfeild-Roberts, and Artemis Alpha Trust, managed by John Dodd.