One of the first things investors learn about BP (LSE: BP) (NYSE: BP.US) and Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) is that they aren’t a pure play on the oil price.
As vertically integrated oil majors, involved in everything from production and exploration, transport and refining, retail distribution and sale of fuel, they have in-built protection against oil price swings.
Clearly, they don’t have enough protection. With the price of about one of Brent crude plunging more than 22%, from $116 in July to below $90, BP and Shell have also taken a hit.
Today, BP is almost 20% down from its 52-week high of 527p. Shell is down around 15% from its year-high of 2613p. Falling oil price expectations have wreaked damage on both stocks.
BP Blow
This isn’t the only factor in their slide. BP has been hit by its close links with the Kremlin, through its Rosneft tie-up, which has put it in the firing line for EU sanctions. It was hit hard by the recent “gross negligence” ruling in the latest chapter of the Deepwater Horizon legal battle epic.
BP’s share price may have been hit too hard, as the ultimate fine may fall short of the £18 billion markets have priced in. Plus of course there is a chance that BP’s strenuous appeals will be heard.
Shell is in a much better place. No Gulf of Mexico scandal, no Kremlin links. Second-quarter profits smashed analyst expectations, with earnings hitting $6.1bn, up from $4.6bn in the previous quarter.
Yes it will also have disappointed investors by its failure to cash in on the shale oil boom, writing down $1.9bn above investments in the US over the third quarter.
The failure of its lengthy search for gas under the Saudi Arabian desert is another disappointment.
Down, Down, Down
But it’s the sliding oil price that is causing most of the harm to this sector. Slowing global growth, weakening China, eurozone deflation have hit demand, while the current supply glut has only upped the pressure.
Instead of cutting production, Opec members such as Saudi Arabia, Iran and Iraq are even cutting prices, especially to key Asian markets, in order to hold onto market share.
Some Opec members will be hoping for another polar vortex in the US, to boost demand over the winter. Others are more sanguine.
Market rumours suggest Saudi will stomach oil at below $80 a barrel for the next year or two, willingly taking a short-term hit to choke off investment in more expensive energy sources, including US shale.
Golden Years
Don’t let this put you off, because today’s troubles are partly reflected in the price. Today, BP trades trades at just 5.6 times earnings and yields a juicy 5.4%. In today’s low interest rate environment, that’s black gold.
Shell is less risky, but more expensive at 13.6 times earnings, with a 5% yield.
Now would be a good time to take advantage of share price fall to pop both into your portfolio. Braver investors might lean to BP, given its lowly valuation.
In today’s turbulent market, their prices could easily fall lower. If so, why not buy a bit more? Then wait, and keep reinvesting those dividends, because the recovery is likely to take time.
