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Is The Tide About To Turn For BP plc & Royal Dutch Shell Plc?

You may be familiar with Shakespeare’s line “There is a tide in the affairs of men which, taken at the flood, leads on to fortune“. Well, that tide may finally be ready to flow in the right direction for FTSE 100 oil majors BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB).

The quote comes from Julius Caesar, which is appropriate, given that the knives are out for BP and Shell. Both are trading notably lower than they were five years ago, and have plunged 30% and 35% respectively in the last 12 months, swept away by the oil price crash.

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Sinking Feeling

Shareholders could suffer more misery if oil falls further. Goldman Sachs has now cut its 2016 Brent oil forecast from $62 to $49.50 a barrel and has warned the price could fall as low as $20 if demand slips. That would leave BP and Shell stranded in the shallows and their dividends could be sunk as well.

Bizarrely, Goldman Sachs simultaneously upgraded its view of BP, if only from sell to neutral. It accepts that cheap oil will challenge BP, but claims that low oil for longer should also allow it to “extract more value from the service change and thereby drive costs lower in its upstream businesses“. That’s one of the benefits of a vertically-integrated oil company.

But the main reason for the upgrade appears to be that BP is cheap, having underperformed the FTSE World Europe by 15% since its downgrade on 16 May. Shell is also cheap, trading at just over eight times earnings, and both offer eye-poppingly generous dividends. BP now yields 7.35% while Shell yields 7.24%.

Shale And Sickly

At some point, the tide will turn, and quite suddenly. Last week’s monthly report from the International Energy Agency (IEA) suggested that Saudi Arabia is winning its price war against US shale and non-Opec production will fall next year by half a million barrels to 57.7 million barrels a day. Once victory seems assured, the Saudis might tighten the spigots again. Riyadh’s break-even oil price is $90 a barrel and it is running a fat deficit to fund its lavish social spending programme to quell unrest at home.

The merest rumour that Saudi is cutting production would send the oil price soaring, with BP and Shell caught in the current. Other factors could also lead to a reversal of fortunes. Wildcat shale drillers aren’t the only victims of cheap oil, pricey North Sea oil is having an even harder time, further hitting supply.

Good Fortune

The IEA expects global oil demand growth to hit a five-year high this year of 1.7m barrels per day. US inventories are falling. China is likely to respond to stock market weakness with another blast of stimulus, reviving growth (for a while). Republicans in Congress could still stymie Obama’s Iran deal, choking off a fresh source of supply. If the Federal Reserve strikes a dovish tone this autumn and the dollar weakens as a result, the oil price could rise.

At some point, the tide is likely to turn in favour of pricier oil. It is still black gold, the fuel driving the global economy. At today’s low prices, investors in BP and Shell might want to go with the flow.

 

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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.

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