BP plc Boss Bob Dudley Is Planning For Cheap Oil: Are You?

After a short-lived rebound, oil stocks are giving up their gains — and I think I know why.

Oil investors are beginning to consider what might happen to their portfolios if the price of oil doesn’t recover.

On Friday, BP (LSE: BP) (NYSE: BP.US) boss Bob Dudley told the BBC that BP was now planning for low oil prices for “certainly a year, I think probably two and maybe three years”.

In this article, I’ll take a look at why BP is doing this — and how you may be able to protect your portfolio.

Too much oil

The reality is that too much oil is being produced: global oil supply is currently around 1.5m-2.0m barrels a day higher than demand. That’s around twice the UK’s daily oil production.

Alongside this, a recent report by Rystad Energy and Morgan Stanley found that the vast majority of global oil production — enough to meet demand — has a production cost of $65 per barrel or less.

To me, this suggests that $65 could be the maximum oil price we will see during the next few years, unless global demand rises faster than expected.

Profits slashed

Mr Dudley’s cautious outlook is certainly reflected in the latest consensus forecasts for BP. Over the last three months, analysts have cut their 2015 profit forecasts for BP by a staggering 35%.

This has left BP shares looking much more expensive than you might expect, on a 2015 forecast P/E of 13.5.

Safe havens?

Interestingly, the outlook for Royal Dutch Shell (LSE: RDSB) is much brighter, perhaps because of its high levels of gas and LNG production. The latest consensus estimates for Shell put the firm on a 2015 forecast P/E of 10.4, which still looks good value to me.

Another firm that should be relatively safe is Soco International (LSE: SIA), where low production costs and net cash of more than $280m should mean that shareholders are relatively safe. However, analysts have also taken a red pen to Soco’s earnings forecasts, and the firm’s shares no longer look especially cheap, on a 2015 forecast P/E of 14.2.

What not to buy

In my view, oil producers with high capex commitments and substantial debt levels, such as Tullow Oil (LSE: TLW) and Enquest (LSE: ENQ), could suffer most of all.

Enquest’s $1bn net debt looks especially risky, in my opinion, despite the firm’s lenders agreeing last week to relax the terms of the debt.

While Tullow’s financial situation is more robust, the firm has $3.1bn in net debt and currently trades on 25 times 2015 forecast earnings. I suspect that there may also be more downside for Tullow shareholders.

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Roland Head owns shares in Royal Dutch Shell. The Motley Fool UK has recommended Tullow Oil. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.