My top oil penny stock to buy right now is EnQuest (LSE: ENQ). This is not the only small-cap oil producer on the London market, but I think it is in the best position to profit from rising sector prices.
Not only will the enterprise benefit from higher prices, but I think investors will also benefit as the company’s profits grow, enabling the group to stabilise its balance sheet.
Penny stock qualities
Most oil and gas companies hedge the price of their production. By using this approach, these enterprises can lock in future cash flows at predefined prices. This means they have some protection from a substantial fall in oil prices. Unfortunately, it also limits gains from rising prices.
According to EnQuest’s latest trading update, the company has locked in 8.6 mmbbls of oil production this year with an average floor price of c.$63/bbl and an average ceiling price of c.$78/bbl.
If the firm is able to meet the upper end of its output target of 51,000/bbl a day in 2022 this means it has hedged roughly 50% of its production at these prices. With the current price of oil averaging more than $100/bbl, EnQuest could be on track for windfall profits this year.
Even if oil prices fall substantially, the company’s decision to lock in a $63/bbl floor should help minimise the risk.
Rising oil prices are one of the reasons why this group is my favourite oil penny stock to buy right now. Another factor is the corporation’s debt. Investors have been avoiding EnQuest for years due to its high level of debt. At the end of December, the company’s net debts amounted to $1.2bn (£900m) compared to its market capitalisation of £422m.
Management was already projecting that debt would fall this year, thanks to lower costs and higher oil prices. With oil prices surging above the company’s expected range, it looks as if the business will have even more flexibility to reduce borrowings.
A stock to buy today
Still, the corporation will have to overcome some challenges. Rising maintenance and wage costs could increase operating costs. There are also growing calls for a windfall tax on energy producers. Such a tax could have a significant impact on the company’s projections. It would undoubtedly force me to revisit my expectations for the business over the next few years.
Even after taking these risks into account, EnQuest remains my top oil penny stock to buy right now, and I would be happy to add it to my portfolio.
In the base-case scenario, I think the company will be able to start reducing debt over the coming year while investing in its operations.
In the best-case scenario, if oil prices remain high, I think the business will be able to take a significant chunk out of its borrowings. In this situation, the market’s opinion of the company could change significantly as it repositions itself on a more sustainable footing.
Rupert Hargreaves has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.