AWE Limited (ASX:AWE) is a small oil and gas explorer and producer. The majority of its operations are located in Australia and New Zealand, though the company is becoming increasingly interested in international operations.

The company's major projects are the onshore Casino gas field (Otway Basin, SA), Cliff Head project (Perth Basin, WA) and the BassGas project (VIC & TAS) and now, the Perth Basin.

Over the last year, AWE has underperformed its peers hurt by a shift in its growth focus from conventional exploration plays to unconventional Australian/US plays. It has also suffered from some reserves downgrades over the past 12 months and it has generally been one of the shares to sell over the period.

Macroeconomic factors have seen significant weakness in the commodities space which has resulted in a huge selloff in resource stocks.

Being an explorer, AWE's share price is largely driven by sentiment and commodity prices. With both turning negative, we feel AWE has significant downside risk.

Earnings need oiling

Last month, AWE announced a FY11 net loss of $117.6 million, which compared to a $28.9 million loss a year earlier.

Excluding one-off items, the underlying loss was $16.1 million.

Revenue for the period fell 14% to $305 million, with oil production down sharply from the prior year. However, this was partly offset by stronger oil prices and gas sales.

This revenue was achieved on production of around 6.1mmboe.

AWE forecast FY12 production of 5.0mmboe - 5.5mmboe, and revenue between $270 million and $300 million.

This production forecast is lower than FY11's production due to a four to six month Bass Gas outage.

It has budgeted $50 million for exploration expenditure and $150 million for development expenditure.

Looking ahead

In its operating budget for FY12, AWE hopes to deliver this revenue at a US$100/bbl brent oil price.

We feel this price is highly optimistic considering the current global economic conditions.

Oil prices are already down to around US$81/bbl with forecasts pointing towards an even lower price.

Just over the past month, brokers have downgraded earnings forecasts for AWE by around 20% to 30%.

During market downturns, investors tend to use share price weakness as an opportunity to buy established producers at significant discounts which leaves the explorers like AWE out to dry.

With risk appetite swiftly disappearing in global markets, we are likely to see energy commodities and subsequently energy stocks like AWE continue to be sold off. It will be one of the stocks to watch in coming months.