At the beginning of 2016, BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) appeared to be two of the most disliked shares in the FTSE 100. Low oil prices put investors off the companies, and their shares plunged to muli-year lows.
Nearly a year on and much has changed for these enterprises. Rather than collapsing under the weight of low oil prices, Shell and BP have shown that they have what it takes to weather the storm and ride out the hostile operating environment. Both companies have returned to profit as cost cuts have improved margins and downstream refining operations have picked up the slack, proving the benefits of a diversified operating model.
Shares in BP have risen 29% year-to-date excluding dividends while shares in Shell have gained 44%, but even after these gains the companies still look attractive.
However, as the price of oil grinds higher, investors could be running out of time to pick up shares in Shell and BP at bargain prices.
The market is changing
Over the past year, the oil market has changed dramatically. Whereas this time last year many oil analysts were predicting a market surplus for the year ahead, now some analysts are saying the market will be balanced/slightly in deficit next year. There’s also talk of an OPEC output cut. The figure being mentioned is around 4%, which doesn’t seem like a lot, although considering OPECs production is around 33m barrels of oil equivalent per day, a 4% cut would take approximately 1.3m boe/d out of the market. Last year it was widely believed that the market’s oversupply was only a few million barrels per day. So, OPEC’s small cut may have a significant impact.
What’s more, after two years of depressed prices, the number of new oil projects being brought on-stream is dwindling, and producers are cannibalising equipment to make capex budgets stretch further. Ultimately, these actions will delay a recovery in production as oil demand rises over the long term.
Overall, these factors are good news for BP and Shell. Higher oil prices will send profits surging at these two oil giants and cost cuts made during the past two years should accelerate the recovery as margins will be wider. BP and Shell have been lowering the bar during the previous two years, and these companies now need lower oil prices than before to generate a profit. Both companies have been targeting a break-even price of $50 to $60/bbl.
Last chance saloon
As the oil market returns to normality, investors are running out of time to buy BP and Shell. The two oil giants still support highly attractive dividend yields of 7.1% and 7.2% respectively and while the payouts aren’t covered by earnings per share yet, it looks as if City analysts believe dividend payouts will be well covered next year.
