Investor appetite for the fossil fuel sector has died down in recent days amid a fresh dip in crude prices.
After moving back above the $40 per barrel marker last month, Brent values have subsequently run out of steam as enduring fears over supply/demand imbalances have come to the fore again.
Oil producers like Shell (LSE: RDSB) and Tullow Oil (LSE: TLW) have been carried higher following Brent’s surge from January’s multi-year lows of $27.67. But with ‘black gold’ back on the defensive, I reckon oil companies big and small are back in danger of a huge share price reversal.
Supply hopes sliding
The recent oil price fightback has been based on a combination of cross-commodity short-covering and misplaced market optimism concerning an OPEC-led production cut.
Cartel members Saudi Arabia, Qatar and Venezuela had — along with Russia — floated the idea of a supply freeze earlier this year in order to ease the strain on bulging global inventories. But the lukewarm reception to any such accord by fellow OPEC heavyweights like Iran have poured cold water on the idea of the pumps being turned down.
Maintaining market share is clearly the name of the game, with each major producing nation reluctant to cede commercial and political advantage by cutting their own supplies. Indeed, news this week that Russian output hit a three-decade high of 10.9m barrels per day in March illustrates Moscow’s real reluctance to curb drilling activity.
Demand deteriorates
On top of this, oil demand indicators also continue to deteriorate, adding fuel to my belief that crude prices remain too high.
Latest Energy Information Administration data showed US gasoline consumption sank by 48,000 barrels per day in January, the first drop in 14 months. This helped push total oil demand 1% lower from the corresponding 2015 period to 19.05m barrels per day.
Aside from patchy demand numbers from the US, the prospect of cooling consumption from commodities ‘hoover’ China also threatens to send crude values through the floor again. Sure, oil imports may have galloped 24% higher year-on-year in February — to 31.8m tonnes — but this is more likely the result of strategic stockpiling than a signal of robust underlying demand.
High price, high risk
These factors mean that both Shell and Tullow Oil are looking chronically overvalued, in my opinion.
Indeed, projected earnings of 105 US cents per share at Shell leaves the company dealing on an elevated P/E rating of 22.5 times, well above the benchmark of 10 times that’s representative of stocks with high risk profiles.
Meanwhile, Tullow Oil deals on an even-higher multiple of 49.2 times as the City anticipates earnings of 8.5 cents per share.
On top of this, Shell also faces questions over whether its current dividend policy remains sustainable — the company has vowed to “at least” match last year’s reward of 188 cents per share. Given the producer’s hulking debt pile and hazardous earnings outlook, I believe investors should be prepared for a colossal cut in the near future.
