Back in April, it looked as if shares in small-cap oil producers Premier Oil(LSE: PMO) and Enquest(LSE: ENQ) were set to make a full recovery from their 2015 losses. However, the recovery story has since unravelled somewhat as the price of oil has fallen back, and investors have become impatient.
Indeed, at the end of April shares in Premier were up 52% on the year, and Enquest's shares had gained 120%. Four months on and these gains have been pulled back to 40.6% and 45.7% respectively.
Enquest and Premier are two of the largest domestic operators in the North Sea and their fortunes are tied to the price of oil. But as oil prices have collapsed, these operators have become dependent not just on the price of oil but also on their managements' ability to adapt to the changing environment. If Enquest and Premier can restructure their operations to be profitable with oil at $50 a barrel then if prices ever recover to 2014 levels, profits will surge thanks to operational gearing. If this scenario plays out, the shares in these companies could double, triple or even quadruple within a short space of time.
It seems that both companies are already making steady progress on their plans to cut costs. For example, today Enquest reported that it had made a pre-tax profit of $74.9m for the first half to the end of June, compared to a loss of $34.6m booked a year earlier. What's more, this higher profit came despite revenue falling from $414.6m to $382.2m. The group's oil production was up 43% year-on-year to an average of 42,250 barrels per day. Management has also been able to cut a total of $570m off the full cost of the company's Kraken development in the North Sea, which is slated to begin production in 2017.
The fruits of Premier's restructuring are paying off as well. For the first half of the year to the end of June, the company reported a pre-tax profit of $110m, compared to a loss of $214.6m last year. Revenue for the period fell from $577m to $393m. The company managed to return to profit thanks to a reduction in per-barrel operating costs to $16.50, 14% below budget.
While Premier has made some impressive changes to its business model to cut costs, I should point out that the company is currently in discussion with its lenders regarding its hefty debt pile. At the end of the first half debt amounted to $2.63bn and management is trying to get lenders to renegotiate the debt covenants in an attempt to avoid being forced into bankruptcy.
Heading in the right direction
Overall it looks as if Premier and Enquest are moving in the right direction. Costs are falling rapidly, production is rising, and these two producers seem to be well positioned to take advantage of higher oil prices if and when they come.
Nonetheless, it's almost impossible to predict where the price of oil will be a week, month or year from now. So while these companies may be making the right noises, there's plenty of uncertainty ahead for shareholders but could the risk be worth the reward?
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Rupert Hargreaves 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.