Last year’s surprise OPEC and non-OPEC oil production cuts were supposed to herald a new area of higher energy prices, but it hasn’t really happened. Oil bulls who predicted oil could hit $60 or $70 a barrel will have been disappointed, with the price stalling around $55. If the price can’t rise now, when will it rise? Or could it even crash?
Oil slip
Any further slippage would spell bad news for FTSE 100 giants BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB). They are banking on a higher oil price to keep the cash flowing, and ensure their dividends are sustainable in the longer run.
BP needs oil prices to hit $60 a barrel just to break even. BP’s dividend costs it more than £7bn a year and this will eventually become unsustainable if oil stays low, with a third now being paid in shares and debt. Latest results showed the company’s year-end net debt climbing to $35.5bn, up from $27.2bn one year earlier, as it battles to fund the dividend, maintain spending and cope with the seemingly endless costs from 2010 Deepwater Horizon disaster. It cannot climb forever.
Roll back the barrel
BP and Shell have both been cutting headcount, squeezing suppliers, slashing capex and disposing of non-core assets in a bid to make their sums add up. Shell is ploughing on with its $30bn asset sale programme, which has helped trim its net debt from $77.8bn to $73.3bn. Before the BG Group takeover, it stood at $26.6bn.
Shell’s recent full-year results showed a $4.3bn drop in profits, from $11.4bn in 2015 to $7.2bn. It paid $15bn of dividends in 2016, of which $5.3bn was paid in shares. Shell has previously suggested it could break even with crude in the mid-$50 range, roughly today’s level. That looks tight to me, and will look even tighter if the oil price dips again.
Played out
The recent OPEC and non-OPEC oil price cuts appear to have been honestly implemented, surprising cynical observers, including myself. Yet oil bulls ignored the fact that there is still a glut of oil to work through, and it is rising rather than falling. The oil price was hit by last week’s figures from American Petroleum Institute, which showed a 14.2m barrel build in its inventory last week, against expectations of a 2.5m build.
Rising shale supply is also offsetting the production cuts: figures from Baker Hughes show the US rig count is up 200 in the last year to 741, plus a rise from 130 to 352 in Canada. Wall Street is pouring money into oil yet investors are banking on the price continuing to rise, holding a record number of long positions.
Investing in BP and Shell today is effectively taking a long position on the oil price. That strategy worked a year ago, with BP up 38% and Shell up 49% since then, while their yields remain strong at 6.65% and 6.28% respectively. They were a good bet a year ago. A risky one today.
