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Are investors becoming too giddy for Royal Dutch Shell plc and BP plc?

Photo: Lane Pearman. Cropped. Licence: https://creativecommons.org/licenses/by/2.0/

Without meaning to sound like a party pooper, I believe investors need to exercise some restraint before piling into the likes of BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB).

Last week’s OPEC production accord continues to drive the share price of the world’s oil majors to the stars. Just today Shell struck fresh 22-month highs above £22.45p per share. And the firm’s FTSE 100 rival has recently ascended to fresh six-week peaks, taking it to spitting distance of October’s highs of around 495p, the best since July 2014.

Cut questions

Now don’t get me wrong: like the rest of the market, I believe that OPEC’s move to shave 1.2m barrels off its daily production quota could prove a gamechanger. But it is far too early to laud the success of the Saudi-led deal.

First of all, latest OPEC production data indicates that the group will have to cut more than the original target to meet its quota of 32.5m barrels per day. The International Energy Agency reported on Thursday that the cartel pumped a fresh record of 34.2m barrels of the black stuff in November.

Concerns already abound over how seriously the cartel will monitor the output of each individual member, particularly as some nations have to suck up swingeing cuts while others such as Iran and Nigeria receive a free pass. And it could be said that November’s production numbers reveal OPEC’s true commitment to reducing production.

Stateside struggles

And looking elsewhere, supply-side news from the US also threatens to lessen the impact of last month’s Doha deal.

Producers in the country have become increasingly adept at tackling crude prices around the $50 per barrel marker, reflected in a steady build in the US rig count. And the latest hardware count from Baker Hughes showed 21 rigs plugged back into the ground, taking the total to 498. This is the biggest weekly rise for more than a year.

Clearly OPEC’s output cut is encouraging North American drillers to get back to work, and this trend looks to worsen in the months ahead, undermining the possibility of further strides in the oil price.

These moves, allied with still-patchy energy demand, threaten to keep inventories locked at bloated. Latest data on Thursday from the American Petroleum Institute showed US stockpiles added an extra 4.9m barrels in the week to December 9.

Too dear?

So there’s still plenty of reason to remain cautious over any hopes of an imminent earnings bounceback at the likes of Shell and BP, in my opinion.

The City expects earnings at BP to more than double year-on-year in 2017, resulting in a P/E ratio of 15.4 times. And an anticipated 73% bottom-line jump at Shell creates an earnings multiple of 19.5 times, some way above the London blue-chip average of 15 times.

But with demand threatening to remain subdued through next year, and supply indicators remaining less-than-reassuring, I believe hopes of sustained strength in the oil price — and with it a robust bottom-line recovery at BP and Shell — are built on shaky foundations. I reckon the risks continue to outweigh the potential rewards at current prices.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has recommended BP and 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.