The collapse in the oil price has been as rapid as it was unexpected. And it continues to break new lows, with Brent crude busting through $50 a barrel last week.
The share prices of FTSE 100-listed oil majors have followed, with BP (LSE: BP) (NYSE: BP.US) falling 20% in the last six months and Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) down 13%.
Many investors will have been looking for an opportunity to build a position in these two stocks. Could this be it?
Down, Down, Down
Things may get worse before they get better. Although political upheaval in Libya has threatened supplies, larger producers such as Saudi Arabia, Russia, Iran and the US are beating their production targets, at least for now.
US oil exports have just hit a 20-year high, as falling oil prices failed to deter US fracking production.
Demand has also fallen, squeezed by deflating Europe and slowing China. Last year, Saudi oil minister Ali Al-Naimi said that even $40 a barrel oil wouldn’t “necessarily dictate a change in output”.
Oil markets may soon test his claim.
High-Energy Yields
Although oil has stabilised at around $50 for now, it is impossible to say whether the next movement will be up or down. Serious long-term investors shouldn’t even try to predict the unpredictable.
But they should note that this has sent BP’s valuation crashing to less than five times earnings, although Shell is pricier at more than 12 times. So you’re getting more stock for your money.
More impressively, BP now yields a juicy 5.79%, while Shell yields 5.2%. If you buy today, you are locking into those energy-rich yields, regardless of where the companies’ share prices move next.
Up, Up, Up
While oil could fall further, it will surely rebound at some point. Many projects can’t pay their way with oil below $60 a barrel, let alone $50, and BP and Shell both face tough decisions on whether to cut back on production and by how much.
More expensive energy sources, whether tar sands, deepwater drilling, Arctic and North Sea oil, shale and renewables, are becoming increasingly uneconomical.
Cheap oil also renders many energy saving measures less compelling.
Peak oil remains a threat (some analysts suggest Russia is already there) and has only been temporarily postponed by the shale boom.
I can see the oil price starting to rebound later this year, especially if OPEC loses its cool and cuts production.
BP and Shell could ultimately find the downturn works in their favour, by forcing them to review their businesses, cut costs, renegotiate contractor charges, drop more expensive operations and shun expensive acquisitions. They could emerge leaner operations, just as the oil price starts to rise.
If that happens, you’ll be glad you topped up your tank when their share prices were low.
