Since the pandemic lows, both BP (LSE: BP) and Shell (LSE: RDSB) have produced outstanding returns for investors who were brave enough to buy – BP is up 77% and Shell 91%. However, the share prices of both FTSE 100 companies have come under pressure recently for two main reasons. Firstly, the emergence of Omicron has led to fears that further lockdowns and travel restrictions will be needed to constrain its spread. Secondly, in order to cool down escalating oil prices, the Biden administration has suggested releasing strategic oil reserves.
Neither reason, in my opinion, changes the underlying investment case for either company. Instead, I believe the pullback has presented an incredible buying opportunity for me. Let me explain why.
In relation to Omicron, there is still so much we do not know including crucially how transmittable it is as well as its ability to evade protection afforded by existing vaccines. What I do see at the moment is no appetite amongst governments to introduce further lockdowns and draconian restrictions, particularly not in the UK. Indeed, countries that have gone down this route have been met with significant public resistance.
On the second point concerning the release of strategic oil reserves, such an action will do nothing to address the supply and demand imbalances that have built up over the last few years driven primarily by the ESG agenda. I would go so far as to say that such a release would be a mere drop in the ocean.
The lack of capital investment in oil and gas exploration is the primary reason to believe that prices will, at least in the short to medium term, continue to rise. Unlike in previous commodity bull markets (leading up to the global financial crisis in 2008 and again in 2014) where the world was swimming in oil and gas, today, nothing could be further from the truth. There is a distinct possibility that we could be facing real shortages this time.
Of course, I could be wrong about near-term rising oil prices. Last month, the US Energy Information Administration predicted that oil prices would remain elevated throughout December but would subsequently drop by about $10 a barrel next year as production of crude ramps up and begins to exceed consumption toward the end of 2022.
The inflation genie out of the bottle
However, the fortunes of BP and Shell are not simply tied to the price of oil. Another related point that is worth bearing in mind is rising inflation expectations. Only this week, the Fed finally ditched referring to inflation as a transitory phenomenon. If inflation continues to surprise to the upside, which I believe is a definite possibility, central banks would be likely to accelerate the timetable for tapering the purchase of financial assets, and rising interest rates could, as a result, just be round the corner. That inevitably will precipitate a market correction and potentially a crash, particularly amongst overvalued US tech stocks. The result of such a sell-off would see a rush of capital into the undervalued, and largely abandoned, commodities sector.
