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Why The Oil Price Collapse Is A Good Thing For BP plc And Royal Dutch Shell Plc

For years it looked like Oil & Gas was the place to be. It was the most popular sector in investment forums, private investors were piling in, and some were making handsome profits. But then came the oil price crash, and the black stuff fell from fetching more than $105 to under $50 per barrel — in fact, Brent Crude has dipped as low as $41 today.

And share prices crashed. To pick a few at random, Premier Oil is down 77% from its peak in early 2011 (and that’s a company that’s well-funded and sitting on substantial resources), SOCO International has dropped 68% in just the past 12 months, Gulf Keystone has lost 93% since its peak in 2012 (albeit with political problems in Iraq getting in the way), and Afren, sadly, is no more.

Bigger means less volatile

Even the FTSE 100’s big two are heading down, but in a much less dramatic fashion. BP (LSE: BP) saw a five-year peak as recently as July 2014, and it’s fallen a relatively modest 27% since then. And over a similar timescale Royal Dutch Shell (LSE: RDSB) has given up 29%.

Although that’s not nice, it’s a lot better than the wipeouts that some smaller oilies have been suffering. And over the long term, I reckon a period of low oil prices will be good for the industry and for investors in BP and Shell.

Back when oil could do no wrong as an investment, there were plenty of small explorers (AIM is littered with them) who were essentially a waste of capital – but when you’re in a bubble sector, it’s easy and cheap to attract the punters’ cash even if it could be used more efficiently elsewhere. With assets being valued at short-term high oil prices and many having no proven assets anyway, there wasn’t enough risk premium to attract a long-term “buy and hold” investor like me.

Shakeout

Now the riskiest ones are being shaken out, and a bigger proportional share of the capital invested in the business is being allocated to the more efficient companies — and those are the biggies like BP and Shell.

BP actually has a couple of years of earnings growth forecast, after a period of cost-cutting and offloading some assets, which puts the shares on a P/E for 2016 of around 12 — and if it’s at the bottom of an earnings cycle, that looks attractive to me, although downgrades due to further price falls seem likely. There’s a dividend yield of nearly 7% predicted, and though it will be barely covered by forecast 2016 earnings, BP will be keen not to cut it.

At Shell the picture is similar, with a forecast P/E dropping to 11 by 2016. There’s a similar dividend yield, of 6.7%, on the cards, and that would be a bit better covered than BP’s. Earnings growth forecasts are lower at Shell, but that’s reflected in the slightly lower valuation.

Big is best

With the costs of shale oil being slashed by the big operators, and with no real need to take on the risk of tiny profitless explorers (unless you really like a gamble), the long-term prospects are definitely moving in favour of the likes of BP and Shell, as far as I can see.

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Alan Oscroft 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.