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Why I’m not buying Royal Dutch Shell or UKOG today

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In the current climate it isn’t difficult to see the oil price charge that has underpinned Royal Dutch Shell’s (LSE: RDSB) recent share price ascent continuing.

The mix of production problems in Venezuela, Libya and Canada, combined with the impact of sanctions on major producer Iran by the US, has helped lift the black gold price in recent months. And these problems are not likely to be spirited away easily or possibly very soon either.

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This is why industry commentators have been frantically upgrading their oil price estimates in recent weeks. Morgan Stanley for one believes that crude has much more territory to claim and is forecasting that the Brent benchmark will average $85 per barrel during the second half of 2018, quite an improvement from levels around $70 seen recently.

Not shelling out

Although investor appetite for Shell has moderated recently, it wouldn’t be a surprise to see its share price barge through the multi-year peaks above $28 sooner rather than later.

I remain concerned, however, over whether oil prices can remain perky over the medium-to-long term and the consequences for Shell’s share value, given that output looks set to continue booming across both North and South America in the years ahead and threatens to sail above global demand growth.

Indeed, some commentators are tipping the oil surplus to return during the latter half of this year. And the decision by OPEC and Russia to take an extra 1m barrels of oil per day out of the ground adds to the likelihood of this material overflow coming back sooner rather than later.

Right now City analysts are expecting Shell to deliver a 77% earnings increase in 2018, and to keep the full-year dividend locked at 188 US cents per share.

A low forward P/E ratio of 12.7 times and a chunky dividend yield of 5.2% may be enough to tempt new investment in the fossil fuel leviathan. But my worries concerning booming production in the years ahead, allied to Shell’s modest exposure to renewable energy sources, still discourage me from buying the stock today.

High risk

The same concerns are deterring me from splashing the cash on UK Oil & Gas Investments (LSE: UKOG), you probably won’t be surprised to hear.

The company is an even riskier selection than Shell though, of course — it currently has no income to offset the colossal cost of dragging its considerable oil reserves out of the ground. UKOG has raised funds via share placings in recent weeks to continue testing work at its core assets like Horse Hill in Surrey, but given the rate of cash burn, further cash-raising efforts could be just around the corner.

On top of this, flow testing figures from the project have so far been underwhelming. And further disappointing results from upcoming tests would prompt a fresh exodus of investors, such is the volatility associated with investment in small-cap oil explorers.

UKOG clearly has plenty of promise but that is all it has right now. In my opinion the risks continue to overshadow the potential rewards at this stage.

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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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