Bad news on SA's inflation rate has meant good news for Sasol. It may appear a bit of a sweeping statement, but it holds true if you look at the effect of the oil price and the rand/US$ exchange rate on the financial results of the petrochemical group.

At the interim results presentation earlier this year, finance director Christine Ramon estimated that Sasol's operating profits would improve by R300m for every $1/barrel rise in the price of oil, and by R600m for every 10c drop in the rand.

When looking at the JSE's oil and chemicals sectors, it's Sasol that sets the trend and is the one favoured by analysts. But to gauge the prospects, you have to take a gamble on the oil price and the rand exchange rate.

Has oil got the potential to rise much beyond its end-May levels of around $130/barrel? Probably. Merrill Lynch recently forecast a $200 price, which would mean a tremendous bonanza for Sasol. A price of $150 certainly looks possible this year.

Sasol announced in May that its headline earnings per share for financial 2008 (year to end-June) were expected to be 50%-60% higher than for the previous financial year, with attributable earnings forecast to rise by 30%-40%.

Most analysts had predicted a 25% rise after the modest 18% rise in headline earnings for the six months to December. In response to Sasol's statement, the share price accelerated to pass the R500 level.

So is Sasol fully priced? Has the market discounted a continued rise in the oil price?

Not really, if you look at some of the key ratios. Assuming a 50% improvement in headline earnings per share, 2008 profits will be around R38. At a share price of about R500, the forward price:earnings ratio is 13:2, the forward earnings yield below 7,6% and the dividend yield 2,5%.

This is not expensive in anybody's book, particularly if you believe the oil price still has some way to go.

Judged on fundamentals alone, Sasol is still a buying opportunity. But there are a number of factors that come into play and that investors should consider:

• Sasol last year entered into hedging transactions for about 30% of its synfuel production, with average floor and ceiling prices of $62,40 and $76,80/barrel. Oil prices were trading well above the ceiling for most of the period. At the interim level this cost the group R1,6bn at the operating profit level.

Ramon says the company expected a long-term crude price "in the mid-80s" but had not yet decided whether it would hedge a portion of synfuel production for financial 2008-2009.

• The group is experiencing some operational problems in key areas and warned at the interim level that its synfuel production was expected to be lower in financial 2008 than its previous guidance. This was due mostly to power outages at the beginning of the year.

But the company's much-vaunted gas-to-liquids (GTL) technology is coming on stream more slowly than expected, amid technological problems at its Oryx GTL facility in Qatar.

• Capital expenditure numbers remain high. Ramon says the group is expecting to spend R50bn over the next three years, but analysts say this is a conservative estimate given the surging costs of skilled labour and materials. Sasol has already cautioned that its Nigerian GTL facility at Escravos will cost about $6bn, higher than originally budgeted for. With gearing already at 32% at the interim stage, Sasol can ill-afford significant cost overruns on any of its projects.

• Sasol is close to finalising its R26bn black economic empowerment deal - SA's largest ever - that will lead to black investors gaining 10% control of the company. But Sasol says the deal will cost the company about R7,2bn to facilitate.

• When it comes to Sasol, there is always an element of political risk. Though the group has improved its political relationship with Pretoria significantly - and last year successfully warded off talk of a windfall tax on profit - the post-Polokwane winds might bring uncertainties.

Soaring global prices might well put pressure on government to review its current regulated petrol and diesel prices. If that were to happen, Sasol could be forced to be more cost-reflective in pricing its synfuel.

Despite these caveats, most analysts rate Sasol one of SA's most attractive stocks and one that should be in every serious portfolio.

Like Sasol the other stock on the oil & gas sector, Oando, also hit new highs of close to R19 in May. But Oando, whose primary listing is on the Nigerian Stock Exchange, is a completely different prospect to Sasol. For one, it cannot shake off the sentiment linked to being a Nigerian company. More crucially, though, the group is facing a number of operational and financial problems.

Oanda remains a play for the high-risk investor only.

In the chemicals sector it seems that diversity is important to deal with rising raw materials prices, often linked to oil. Most chemical prices have been rising sharply in line with the commodities boom, but higher input costs have squeezed margins in some businesses.

Diversity, of course, is not the only defence available for these companies. Market dominance, such as Afrox enjoys in its gas business, can be a great help. Though plagued by occasional supply problems, Afrox has enjoyed strong growth based on ever-rising gas prices. As consumers are increasingly switching to gas as a primary energy source - given Eskom's blackouts - demand will continue to drive prices higher.

Of the more diversified chemical companies neither Omnia nor AECI looks in particularly good shape.

Omnia's interim headline earnings at least showed good growth, despite tighter margins in two of its three operating divisions, mining explosives and chemicals. "The margins in some areas are lower than they should be," CE Rod Humphris said earlier this year. "We've taken steps to rectify that and will walk away from business if it is not at an acceptable margin."

AECI, whose main businesses are in explosives, chemicals and property, had a terrible financial 2007, when operating profit fell almost a third and operating margins declined to 9% from 14% a year earlier. But the share price has held steady at around R65 since - after management said it was positioned to deliver improved results through to 2010. Analysts tend to concur, particularly since AECI has since restructured, selling off Dulux Paint and its loss-making Sans Fibres businesses.

An interesting new addition to the sector is Freeworld Coatings, a paint and coatings manufacturer spun out off Barloworld in December last year. Though it is the smallest stock in the sector, with a R2bn market cap, it started with a conservative p:e rating of 7,6 and has held operating margins at 16,3% for the past three years.