The collapse in the oil price to around $80 for a barrel was sudden and unexpected, which suggests that any rebound could be equally sudden and unexpected.
Many in the oil industry see $80 as a strong floor price. At the point investment dries up, hitting drillers, cutting rig count, knocking US shale margins, cutting supply and ultimately, driving the oil price back up.
Breaking Bad
$80 oil may also persuade OPEC members to cut production, as their fiscal break-even points are blown apart. Saudi Arabia needs oil at $99 for its national budget to balance, according to latest figures from Deutsche Bank, while Oman ($101), Nigeria ($126), Bahrain ($136) and Venezuela ($162) are all in trouble at today’s price.
What makes matters harder for investors is that we don’t know what has really driven the collapse in the oil price. Is it the China slowdown? The deflating eurozone? US shale? Growing renewables usage? Milder weather? A Saudi Arabian power play to drive out higher-cost rivals? Or are spooks in the US using cheap oil as a weapon to squeeze Russia, Iran and Venezuela?
Nobody Knows
All we do know is that oil is down around $80 a barrel, and the share prices of UK-listed oil giants BP (LSE: BP) (NYSE: BP.US) and Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) are in a similar downwards spiral.
At today’s price of 439p, BP is down nearly 17% from its 52-week high, while at 2335p, Shell is down nearly 11%.
This isn’t all down to sliding oil. BP has problems of its own, as the $43bn Gulf of Mexico litigation show drags on, and Western sanctions menace its 20% stake in Kremlin-controlled Rosneft.
These have overshadowed BP’s impressive continuing recovery, which has seen it boost production, maintain cash flows, cut capital expenditure and hike its dividend.
Which makes today’s valuation of 5.6 times earnings, combined with a juicy yield of 5.3%, a tempting entry point for long-term investors.
Drive Time
Shell has fewer troubles, with Q3 earnings up from $4.2bn to $5.3bn. Production fell 5% and oil price volatility is hurting, but management is responding sensibly, by cutting spending and improving profit margins.
You therefore pay more for Shell, which trades at 13.9 times earnings, and offers a slightly lower yield of 4.9%. If you can stand the extra risk, BP looks the better bargain today.
The world still runs on oil. At some point, the price is likely to rebound. And when it does, BP and Shell are nicely placed to follow.
