They’ve been predicting the end of the oil age for years, but it hasn’t happened yet. No commodity comes close to matching black gold’s importance to the global economy.
Demand keeps rising, particularly from emerging markets. In 2007, the industry supplied 84.6 million barrels of oil a day. Last year, supply topped 90 million barrels.
The International Energy Agency (IEA) in Paris estimates consumption will increase by at least another 50% by 2030.
Troubled Waters
Peak oil stubbornly refuses to strike, but there is no doubt that oil is getting harder and costlier to access. New reserves tend to be found miles under the ocean floor, or in the wilder parts of the world, such as the Middle East and Arctic.
This poses a major challenge to London-listed oil giants such as BP (LSE: BP) (NYSE: BP.US) and Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US).
How Low Can You Go?
One challenge is cost. When oil explorer Edwin Drake drilled what is said to be the world’s first commercial oil well at Titusville in Pennsylvania, he struck black gold just 21m below the ground.
On Sakhalin Island, the Russians have successfully drilled for oil nearly eight miles down, and more than seven miles out under the ocean.
As the oil price rises, these crazy and costly operations start to make financial sense.
Shale And Hearty
Yet the oil price has fallen lately. The price of a barrel of Brent crude has dropped from $116 in June to less than $105 today, as increased supply from US shale deposits and restored Libyan production sooths fears over Iraq and Russia.
Some analysts say oil could slide further, possibly below $90 a barrel, which will put pressure on the share prices of oil companies such as BP and Shell.
Personally, I can’t see that happening. Not with the Middle East in uproar, sanctions hovering over Russia, and swing producer Saudi Arabia needing a break-even oil price of $93 a barrel.
Brace Yourself for Volatility
The oil is likely to become subject to wilder swings. Since 2011, it has fluctuated between $90 and $130 a barrel, and volatility has been low. But history shows that oil price volatility is cyclical, with periods of high volatility following spells of low volatility.
It wouldn’t take much of a shock for the price to spiral upwards again. This could make now a tempting entry point into the oil majors.
BP Is Cheap Right Now
BP and Shell both posted impressive Q2 results last week. BP’s underlying quarterly profit of $3.6 billion was up 34% on last year, Shell’s industry-adjusted earnings rose 33% to $6.1 billion.
Right now, Shell looks the surer bet, given BP’s continuing US litigation woes following the Deepwater Horizon disaster, and its politically awkward 20% stake in Kremlin-owned Rosneft.
Yet BP may be the better recovery play. Its recent worries have left it trading at just 6.6 times earnings, against 16 times earnings for Shell. It could be some years before BP returns to form, but a rising dividend will reward your patience. BP yields a forecast 5.1% for December 2015, against 4.6% for Shell.
The oil age won’t last forever. But as yet, nobody has come up with something better. Until they do, BP and Shell will both remain key holdings for long-term dividend investors.
