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Why Markets Won’t Always Be So Forgiving Towards Royal Dutch Shell Plc And BP plc…

It is always wise to shatter investor illusions before you deliver your results, rather than afterwards.

And the markets were certainly under no illusions about the prospects for oil majors BP (LSE: BP) (NYSE: BP.US) and Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US).

When the market price for your primary product has halved in a matter of months, all you can do is hope for the best.

And this week, both companies delivered far better first-quarter results than investors expected.

Shell saw net income fall by a whopping 56% in the first quarter but its share price nevertheless rose 1% as a result. BP reported a hefty 57% drop in pre-tax revenues and its share price hopped 1.5% in consequence.

Investor expectations were low and both companies easily exceeded them. BP and Shell may find it difficult to pull the same trick twice. 

Profits Crash, Share Prices Rise

A doubling in profits at its downstream business helped BP keep its head above water. That partly offset collapsing profits in its upstream business, down from $4.40bn to just £0.6bn year-on-year.

BP’s management has fought a successful rearguard action by improving refining margins, boosting petrochemicals profits and cutting back on capex. A 10% hike in this dividend helped maintain investor spirits.

Shell pursued a similar strategy, cutting capex and basking in the relative success of its refinery division, and holding its generous dividend.

Both companies know they can only hold the fort for so long, until the seventh cavalry comes to their rescue in the shape of a rebound in the oil price.

As investment falls away in the face of cheap oil, investors are calculating that production will inevitably follow, and will have taken heart from Brent crude recently rising above $65 a barrel.

Dead Cats And Wild Cats

This looks more like a dead cat bounce to me. US shale production costs are falling faster than prices, and wildcat drillers are flexible enough to hike production in response to higher prices.

Iranian oil will leak back into the market over the next year. Renewables are getting cheaper, and enjoying a further boost from dramatic improvements in battery life. The US looks set to be a major player in liquefied natural gas (LNG) exports. Opec has been weakened. Oil inventories remain near their all-time highs. Global growth is slowing.

Investors are unlikely to turn against BP and Shell while their respective dividends of 5.07% and 5.45% remain secure.

So this week, markets were forgiving. Next time, they may take a less lenient view.

BP and Shell aren't the only FTSE 100 giants paying juicy dividends. The FTSE 100 is packed with top stocks paying as much as 5% or 6% a year.

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Harvey Jones 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.