After reaching multi-year lows, the oil price is finally recovering. But does this mean you should take the plunge and buy into major oil companies like BP (LSE:BP) and Royal Dutch Shell (LSE: RDSB)?
Let’s set the context first. The oil price has risen to $40 a barrel from $30 a barrel. That’s quite an increase, but you have to consider that two years ago the price of Brent crude was a comparatively massive $110 a barrel. You could argue that this is the beginning of a substantial recovery in the oil price. Or you could say that the increase is part…
Let’s set the context first. The oil price has risen to $40 a barrel from $30 a barrel. That’s quite an increase, but you have to consider that two years ago the price of Brent crude was a comparatively massive $110 a barrel. You could argue that this is the beginning of a substantial recovery in the oil price. Or you could say that the increase is part of normal week-to-week and month-to-month fluctuations. Which is it?
The commodities bull market is over
The oil price story is really all about long-term cycles of supply and demand. Just as stock markets have bull and bear markets, so do commodity markets. We have come to the end of a 17-year bull market in oil, gas, metals and minerals. And that’s bad news for oil company shareholders.
We’re at the beginning of a 17-year bear market in commodities, and this means the trend is only pointing in one direction.Yes, that’s right, it’s downwards. Surging oil prices in the bull market once led to huge profits for BP and Royal Dutch Shell. But it also meant an influx of investment in exploration and production. This then led on to a burst of new oil wells from Saudi Arabia to Russia and Alaska, as well as a boom in shale oil, and in the mining of the oil sands of Alberta, Canada.
And there will be no rapid recovery
The crucial point is that this rise in production globally was no short-term phenomenon linked to the high oil price. Once the oil production infrastructure had been built, it cost very little to keep the wells pumping out hydrocarbons, even in the face of an oil price that was rapidly heading south as China’s growth slowdown affected the rest of the world. But the rise in supply, while demand is largely static, means that the oil price will inevitably fall. And even if the price is low, it makes sense to keep pumping the oil out.
The scale and speed of the fall in the price of crude means that the massive profits of BP and Shell have rapidly gone into reverse. The impact has been felt particularly severely in the North Sea, where the oil industry is barely viable. And the impact extends beyond the oil majors to oil services and maintenance companies such as Petrofac and Schlumberger. Sadly, tens of thousands of jobs have been lost.
So if you’re a BP or Shell shareholder my advice is to sell your shares. And if you’re an investor looking for new opportunities, I would steer clear of the oil industry.
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Prabhat Sakya has no position in any shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.