Why A Higher Oil Price Is Great News For BP plc And Royal Dutch Shell Plc

2014 has been kind to investors in BP (LSE: BP) (NYSE: BP.US) and Shell (LSE: RDSB) (NYSE: RDS-B.US), with both oil majors outperforming the FTSE 100 year-to-date. Indeed, while the FTSE 100 is currently up around 1% in 2014, Shell is up 10% and BP has made gains of 4% over the same time period.

However, with the price of oil continuing to push northwards mainly due to continued unrest in the Middle East, now could be a great time to buy shares in Shell and BP. Here’s why.

royal dutch shellA Higher Oil Price Means Higher Profits

Although quite a simplistic argument, it continues to hold true even for oil majors such as BP and Shell. A higher oil price does not impact upon the costs to extract ‘black gold’ and, as a result, does not increase the cost base of an oil company. However, a higher oil price does have a hugely positive impact upon revenue and means that, while BP and Shell have struggled to improve profitability in recent years, they both look set to be the beneficiaries of a significant tailwind going forward.

Market Sentiment Is Picking Up

Of course, the market is well aware that a higher oil price is good news for BP and Shell, so while both stocks have experienced a challenging period over the last few years (BP is still recovering from the Gulf of Mexico oil spill and Shell is struggling to grow its bottom line), market sentiment has picked up markedly in 2014. As more investors realise that both companies are financially sound and employ sound strategies through which to deliver growth, demand for shares could continue to pick up and push share prices higher.

bpA Low Valuation

Even though BP and Shell have experienced a strong first half of 2014, both companies still offer great value at current price levels. For instance, Shell’s price to earnings (P/E) ratio is just 11.4, while BP trades on a P/E of just 10.6. Both compare favourably to the FTSE 100’s P/E of 14.2, meaning the valuation gap between the two companies and the wider index could be narrowed in future. As a result, Shell and BP could prove to be strong performers over the medium term.

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Peter owns shares in BP and Shell.