Could Shares In BP plc And Royal Dutch Shell Plc Collapse By More Than A Third?!

Royston Wild explains why shares in BP plc (LON: BP) and Royal Dutch Shell Plc (LON: RDSB are in severe peril of a sharp correction.

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Shares across much of the oil sector have received a massive fillip in recent months in line with a recovery in the crude oil price. After the Brent barometer shuttled from $115 per barrel last summer to multi-year lows around $45 in January, a subsequent reduction in the US rig count has underpinned a solid price recovery — indeed, the benchmark was recently trading around the $64 mark.

With investors hoping these measures will represent a sea-change in the oil market’s supply/demand dynamics from next year, shares in oil major BP (LSE: BP) (NYSE: BP.US) have flipped 10% higher since the turn of the year. Investor sentiment in Shell (LSE: RDSB) (NYSE: RDS-B.US) has wavered more recently, however, and the stock is now trading 11% lower from the close of 2014.

Crashing correction on the horizon?

However, I believe that both Shell and BP could still be considered as grossly overvalued, and a quick look at the earnings forecasts at both companies certainly backs this up. Based on projected earnings of 199 US cents per share for 2015, Shell currently changes hands on an elevated P/E multiple of 15.2 times, while its industry peer deals on a reading of 17.9 times amidst earnings expectations of 25.3p.

I would expect a reading closer to the bargain watermark of 10 times to be a fairer reflection of the risks facing the fossil fuel giants this year and beyond. Consequently I reckon Shell should be trading closer to 1,300p per share, a 35% downgrade from current levels around 1,990p. And BP is due for a colossal 48% cut to its current price, to 235p per share from 453p recently. 

Pumpers keep on pumping

And I believe that signs of worsening oil market fundamentals could put make such hefty falls a very real possibility. News agency Reuters claims to have seen a draft strategy this week from industry cartel OPEC, the document predicting that output from non-member countries will continue to steadily rise until 2017 at the earliest.

And OPEC remains reluctant to curtail its own pumping activity to defend market share — indeed, Iran’s deputy oil minister Rokneddin Javadi commented just today that an output reduction is unlikely to be agreed upon at the group’s June meeting.

Meanwhile, the steady stream of negative data coming out of commodities glutton China is exacerbating worries that supply levels will continue to outstrip global demand growth. Latest HSBC Manufacturing PMI numbers came in at 49.1 for May, the fifth month out of the last six that factory floor activity has been in a state of contraction.

Given these factors I believe that the world’s crude stockpiles are destined to remain at breaking point for some time to come. As a consequence I find it difficult to see how BP and Shell will turn around their battered bottom lines any time soon, while a flurry of asset divestments and reduced capex spend is casting a pall over their long-term growth prospects, too. In my opinion both stocks are in danger of a severe share price collapse as the oil market outlook becomes ever gloomier.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Royston Wild has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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