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How Much Further Do BP plc And Royal Dutch Shell Plc Have To Fall?

To say that 2015 has represented another ‘annus horribilis’ for the oil industry would be something of a colossal understatement. Of course the year has yet to run its course, and the fossil fuel sector will be pinning their hopes on a ‘Santa Rally’ to put down a marker for 2016.

I am far from optimistic over the likelihood of such a scenario, however, and believe that industry giants like BP (LSE: BP) and Shell (LSE: RDSB) — firms that have seen their share prices dip 6% and 25% correspondingly since the turn of the year — have much more ground to concede.

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Data from the Energy Information Administration released yesterday showed US crude stockpiles rise for a ninth straight week, and current levels of 488.2 million barrels are a whisker below the modern record just above 490 million barrels. Suffocating supply levels continue to keep Brent prices hemmed in below the critical $50 per barrel marker.

And as output in the country’s most productive fields picks up, adding to the abundant supply of OPEC and Russia, I expect crude prices to remain under pressure. Furthermore, should commodity glutton China’s economy continue to decelerate sharply, I reckon oil is in severe danger of plunging much, much lower — indeed, many brokers are still predicting $20 oil in the near future.

So what prices should BP and Shell be dealing at?

Well, when you consider the sickly revenues outlook facing the oil industry, I believe a share price correction in alignment with a P/E rating of 10 times would be a ‘just’ valuation for the likes of BP and Shell. Stocks dealing at these levels are generally ones loaded with turbulent market conditions, battered balance sheets and the like.

The City currently expects BP to chalk up a 63% earnings advance in 2015, leaving the business dealing on a prospective P/E rating of 16.3 times. A subsequent re-rating to the benchmark of 10 times would leave the business dealing at 220p per share, representing a 44% reduction from current levels. And I believe even this figure could be considered generous given the likely impact of crude market problems on BP’s likely earnings performance this year and beyond.

Bottom-line predictions over at Shell are far more realistic, and a 40% earnings decline is currently predicted. But this could also be considered a tad heady given a subsequent P/E rating of 13.9 times — an appropriate re-rating would leave the oil giant changing hands at £12 per share, a 29% dip from current prices.

Don’t bank on decent dividends!

Sure, some would point to the fossil fuel plays’ massive dividend yields as justification of their seemingly-elevated share prices. Shell and BP are expected to fork out payments of 188 US cents and 39.4 cents respectively in 2015, creating sizeable yields of 7.5% and 6.8%.

But the fact the City now expects both businesses to keep dividends frozen from last year, compared with the chunky rises predicted just recently, illustrates the growing stress on both firms’ balance sheets.

And even though BP and Shell remain engaged on capex reductions and cost-cutting to mitigate falling revenues, I reckon current dividend forecasts are in severe danger of missing, and that both operators may be forced to follow the likes of Vedanta Resources and Glencore and slash the payout. Should this one pillar of strength be removed, I would expect shares in BP and Shell to fall through the floor.

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Royston Wild 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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