Smaller Companies: Good value lurks in oil exploration shares

THANKS to the soaring stock market, there are few genuinely cheap shares left for bargain- hunters. But some good value can still be found among the oil and gas exploration stocks, especially if crude oil prices go up in the next few days.

The sector has been out of favour for about two years because of weak oil prices, recession, a strong pound and the poor financial position of some oil companies.

As a result, many oil exploration and production (E&P) stocks have been trading at a significant discount to asset values.

Sentiment has been helped by higher trading activity in North Sea assets. Several prominent portfolios of oil and gas interests changed hands at good prices recently, underpinning values.

The dollar has also moved up sharply, which should boost oil companies' revenues in sterling terms, and oil demand may also rise this year due to an improving American economy.

One key negative factor that has held back the sector is a serious oil glut because of overproduction by the Organisation of Petroleum Exporting Countries, the oil cartel.

Shares in Hardy, Kingston and Monument provide upside potential. Both have a good exposure to the US gas market, where prices have been firming due to increased demand and damage caused to pipelines by Hurricane Andrew last year.

Hardy also has a good exploration record, while Kingston owns Orcol Fuels, a UK engine oil recyling business. Orcol, which acquires its raw material from garages, has been hit by weaker margins due to the recession, but is expected to benefit from new environmental regulations on the safe disposal of used lubricants. It has recently won formal endorsement from Shell as one of its approved handlers of waste oils.

Monument also has a strong record of finding oil and an international spread of assets. But its biggest potential is linked to a large new oil and gas development project in Liverpool Bay. Monument has a 25 per cent interest in three fields containing 1,000 billion cubic feet of gas and at least 100 million barrels of oil.

The project is being evaluated by the Government as part of its coal pits review because gas from the fields is suitable only for burning in power stations.

The project's chances were boosted last week after it obtained planning consent for an oil and gas terminal in North Wales. It also appeared to receive guarded support from the recent select committee report on energy policy.

If it obtains final approval from the Government, Monument's shares should soar. Either way, they are attractive, though Monument does not pay a dividend. All three companies' shares are trading significantly below asset values.

Kingston and Monument are also debt-free, while Hardy's borrowings amount to a third of shareholders' funds.