The oil market’s been almost impossible to predict over the past 12 months and many believe that this will continue to be the case for the foreseeable future.
However, an increasing number of City analysts, traders and oil company managers think that sooner or later the oil market will return to normality. Supply growth will stall and demand will rise to meet output. There’s plenty of evidence to back up this conclusion.
Oil demand is rising almost every day and while the market is still oversupplied, oil companies are slashing capital spending budgets. There are some 150 oil and gas projects that have been delayed or cancelled globally in response to lower oil prices, taking an estimated 19 million barrels per day of future production off the market. What’s more, because of reduced maintenance investment in mature offshore sources, decline rates are set to double to 1.5m BOPD during the coming 12 months.
So, it looks as if the price of oil is set to stage a recovery at some point in the future and Royal Dutch Shell (LSE: RDSB) could be the best way to play this trend.
Built for the long haul
Shell is built around the traditional ‘Big Oil’ model, which is designed to ensure that the company remains profitable through all stages of the oil market cycle. Specifically, the company’s upstream (production) operations are highly profitable when the price of oil is high but when oil prices fall, the group’s downstream (refining, trading and marketing) operations pick up the slack.
For example, Shell and France’s Total are the world’s largest oil traders, handling enough fuel every day to meet the needs of Japan, India, Germany, France, Italy, Spain, and the Netherlands. Shell’s first-half refining and marketing profits jumped 93% year-on-year to $5.6bn.
Shell’s downstream operations will keep the company ticking over until the price of oil starts to push higher and when it does, the company’s profits will charge higher.
Moreover, Shell is currently in the process of acquiring peer BG Group, which will give the company even more exposure and leverage to the price of oil. Management estimates that it can cut $2bn of costs from the enlarged group after it merges with BG. Also Shell’s figures show that when combined, Shell/BG will be able to save $1.5bn per annum on exploration activities as the enlarged group spends less on searching for new oil fields.
When Shell finally gets the green light from regulators to acquire BG, the merged group will become the world’s largest LNG trader and Shell’s daily oil production will increase by around a fifth. So this deal is clearly a play on higher oil prices.
The best way to play the oil price
If you think oil is heading higher, Shell could be the best way to play it. The company’s shares currently support a dividend yield of 8%, so investors will be paid to wait for the recovery to take place.
