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BP plc And Royal Dutch Shell Plc: Just How Low Will The Oil Price Fall?

bpIs there anything as controversial as the oil price?

I have recently been wary of investing in oil companies such as BP (LSE: BP) and, to a lesser extent, Royal Dutch Shell (LSE: RDSB). From my point of view, we live in a world where oil is increasingly difficult to find and to extract. And most of the remaining reserves in the world are owned by state oil companies, rather than the majors.

The oil price is tumbling

This means that the oil companies are having to spend much more money extracting oil, whether it be from the depths of the ocean, the Arctic or the Athabasca oil sands. However, one positive for these firms has been the oil price. The historically high price levels has meant that oil has, nonetheless, still been a highly profitable industry. Until now.

Since June 2014 the oil price has fallen from $115 to $85 – that’s quite a fall. And it could still fall further. In recent months commodities across the board have been falling. The mining companies have been suffering as the iron ore price has tumbled. I think that this may be part of a broader cyclical downtrend in commodities as we move from commodities bull market to bear market. Now the oil companies are suffering, too.

This may be uncomfortable reading

I know that investors won’t like to hear this, but an oil price fall of this magnitude, if sustained, will have a massive impact on BP and Shell’s profits. It may mean that consensus has overestimated profitability, and that these businesses are not as cheap as they seem.

What’s more, a lower oil price may have a longer-term effect on the oil industry. Suddenly, projects that the oil companies are investing in will no longer be viable. It may mean that these businesses will need to scale back their exploration and production spend. This will also have an impact on services companies such as Petrofac and Schlumberger. Is the oil industry beginning to embark on a smaller-scale future?

There used to be a lot of discussion about peak oil. In terms of consumption, we may have already passed peak oil. We no longer use oil to heat our homes. Cars are becoming increasingly fuel efficient, and a growing proportion are hybrid or electric. Renewable energy is just on the cusp of taking off. The energy industry is in transition.

The Stone Age didn’t end because we ran out of stones. The oil age could end long before we run out of oil.

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Prabhat Sakya has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.