Today I’m looking at the critical reasons to sell out of Royal Dutch Shell (LSE: RDSB).
A drop in the ocean
The oil sector’s major players breathed a huge sigh of relief last week after OPEC — responsible for four-tenths of the world’s oil supply — confounded the expectations of many and agreed to cut its output.
Saudi Arabia brokered a deal that will see production fall by 1.2m barrels per day, to 32.5m barrels beginning in January. The news prompted Brent oil to top the $55 per barrel marker for the first time since the summer of 2016.
While a step in the right direction, there are doubts as to whether these cuts are swingeing enough to make a marked difference in eroding the oil market’s hulking supply/demand balance. Indeed, brokers at Marex Spectron believe a cut of around 2m barrels per day is required to improve the market’s poor fundamentals.
The huge political and economic considerations of last week’s agreed cuts are already casting a shadow over the current deal being extended beyond the middle of next year. Clearly it’s too early to claim that OPEC’s latest move will prove a game changer for the oil industry’s earnings outlook.
US plugging in
But the future of OPEC’s current agreement isn’t the only supply-side worry hanging over the oil market, with US producers already returning to work with gusto.
Baker Hughes data last week showed another three rigs being plugged back into the ground in the last week, taking the total to 477 units. This is now the highest level since January.
North American producers have been growing increasingly accustomed to operating in the sub-$50 per barrel environment. And the recent oil price bump is likely to see even more drillers getting back to work, putting hopes of a rebalancing of the oil market in 2017 under some stress.
Demand set to drag?
At the same time, predictions of a significant improvement in energy demand could also be considered on shaky ground.
The International Energy Agency (IEA), for one, has said that it expects global oil off-take to grow by 1.2m barrels per day in 2017, matching levels punched in the current year. This is down from 1.8m barrels in 2015.
The IEA commented that “there is currently little evidence to suggest that economic activity is sufficiently robust to deliver higher oil demand growth, and any stimulus that might have been provided at the end of 2015 and in the early part of 2016 when crude oil prices fell below $30 a barrel is now in the past.”
Too pricey
But in my opinion Shell’s share price fails to fairly reflect the colossal risks posed by a weak global economy and murky supply picture.
Last week’s fresh surge leaves Shell dealing on a forward P/E ratio of 25.8 times, sailing well above the FTSE 100 average of 15 times.
And while a 7.2% dividend yield blasts those of its big-cap rivals, I reckon the oil leviathan’s shaky earnings outlook and exploding debt pile could put hopes of another 188 US cents-per-share reward on the block.
I reckon the troubles facing Shell are too great to justify investment at the present time.
