MARKET COMMENT
What Price An Investment In Oil?

By Maynard Paton (TMFMayn)
November 16, 2001

Carburton Street, London -- The price of oil is in freefall. After surging to $30 a barrel just after September 11th, it's been downhill ever since. Oil now stands at around $17 a barrel. A global softening in demand, plus the outbreak of a price war between OPEC and non-OPEC producers, has underpinned the decline.

While the fall in the oil price has sent oil shares tumbling, investors ought to look back a few years. During 1998, the price of oil collapsed to under $10 a barrel. But suddenly, just as the oil industry was then looking into the abyss, things quickly righted themselves and oil shares promptly surged. For instance, between their 1998 low and 2000 high, shares in Shell (LSE: SHEL) more than doubled. So, for those looking for an oil price rebound after the current malaise, what price represents "great value" for a major oil company?

Here's how the three FTSE 100 oil firms stack up at the moment.

Company          Share Price     Market Value   P/E   Dividend
                      (p)            (£m)               Yield
                                                         (%)

BP                    492          110,245      11.8    2.99  
Shell                 456           44.454      12.2    3.36
Enterprise Oil        433            2,083       6.1    1.94

Company          Share Price   P/E   Dividend
                      (p)             Yield
                                       (%)

BP                    369      43.8    3.22  
Shell                 304      28.1    4.44
Enterprise Oil        224      92.2    3.08

In terms of an oil company's valuation, one thing is clear from the second table: don't place too much emphasis on the price to earnings (P/E) ratio during a crisis.

An oil company's profits are, as you would expect, highly sensitive to the movement in the oil price. For instance, earnings per share at BP (LSE: BP.) fell from 27.4p in 1996 to 8.4p in 1998, but then jumped to 39.5p in 2000. Thus, from the high P/E ratios seen during 1998, investors do tend to expect some sort of recovery after a substantial fall in profits. Although oil shares fall when the oil price falls, don't expect the shares to drop in tandem with the company's earnings.

Thus, with oil companies having highly volatile profits, it's worth using the more dependable dividend payment as a valuation benchmark.

So, using the dividend yields seen during the 1998 crisis, rough target prices can be produced:

Company            1998 Dividend    Prospective      Target
                      Yield        2001 Dividend     Price
                       (%)              (p)           (p)

BP                    3.22             14.7           457
Shell                 4.44             15.3           345
Enterprise Oil        3.08              8.4           272

Of course, oil may have to fall towards $10 a barrel for those target prices to appear. But the calculations do highlight possible "great value" entry points should oil continue its decline. Of the three, BP looks the nearest to having any sort of crisis priced into the shares at the moment.

More: Oil & Gas Sector discussion board | BP discussion board | Shell discussion board | Enterprise Oil discussion board