Oil has been a tough sector for investors in recent years. The imbalance between demand and supply has caused a severe and sustained fall in the price of black gold, with it reaching a low of around $28 per barrel earlier this year. However, its future is a lot brighter than recent past and now could be a good time to buy oil-focused stocks such as Wood Group(LSE: WG) and Premier Oil(LSE: PMO).
An improving environment
The recent OPEC deal could prove to be a game changer for the oil price. The cartel has agreed to cut production and this could help to rebalance the market. While it will take time for the full impact of the move to be visible, over the course of 2017 demand is expected to catch up with supply so as to reduce the oil surplus which is currently present. This means that the oil price is likely to stage a recovery and could return to significantly higher levels than at the present time.
This would clearly be positive for oil-focused companies such as Wood Group and Premier Oil. Looking beyond 2017, the oil price has the potential to rise yet further since exploration spend has declined as profitability across the sector has come under pressure. This means that there could be an oil deficit over the medium term - especially if demand from emerging economies continues to rise.
An upbeat outlook
The effect of a higher oil price on Wood Group is unlikely to be felt in the short run. In today's update, the company states that its markets have remained challenging of late. It also expects to see significant challenges in 2017, although there are signs that there's a modest recovery starting to take place. As such, its short-term performance could disappoint, but over the medium term it has significant total return potential.
Wood Group is increasing its dividend for 2016 by a double-digit percentage. This shows that it has confidence in its future outlook following cost reductions and efficiencies. They position the company favourably for a potential recovery across the sector. Similarly, Premier Oil has reduced costs and acquired assets such as Eon's North Sea assets. This has created a better business which is more able to cope with the volatility that could lie ahead.
Although both companies have endured a difficult period that could continue in the short run, over time their performance is likely to improve. Wood Group's update shows that it has confidence in its future prospects, while its sound financial footing and lower cost base mean that it's in a strong position to capitalise on a higher oil price.
Similarly, Premier Oil is in better shape than a couple of years ago and is due to return to profitability in the current year. As such, now could prove to be the right time to buy both of them for the long term.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.