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Why Buying BP plc & Royal Dutch Shell Plc Is Utter Madness!

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Another day, another chance for further harrowing weakness across stock markets and commodity classes. And so it has come to pass.

Brent values fell even further below the $30 per barrel marker during Friday trade, marking fresh nadirs not seen since 2004. The benchmark has dropped more than 10% since the start of the week, and levels of $60 per barrel seen just six months ago seem a very, very long way away.

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While fossil fuel plays BP (LSE: BP) and Shell (LSE: RDSB) have suffered fresh weakness as a result — the operators’ share prices are down 5% and 12% respectively since 2016 kicked off — I believe investors should resist attempting to pick up a bargain.

Forecasts continue to fall

Just how far crude’s price slump has left in the tank is anyone’s guess. But broker consensus seems to suggest that prices are only heading one way, and that is down.

Analysts over at Royal Bank of Scotland advised this week that oil could topple as low as $16 per barrel during 2016, a projection that comes hot on the heels of $20-per-barrel estimates by both Morgan Stanley and Goldman Sachs.

And the number crunchers over at Jefferies are even more biting — their forecasts suggests that crude values could even fall as low as $10!

Pumpers keep on pumping!

Such bearishness comes as little surprise as the oil industry flat-out refuses to get a handle on a worsening supply/demand outlook.

Just today Russian energy minister Alexander Novak said that co-ordinated steps to cut output with OPEC are “unlikely” given the level of discord across the cartel concerning future production levels. Russia has previously refused to cut its own output, asserting that would be difficult to ramp production back up again given the country’s tough climate.

Meanwhile, US production is also continuing to tick higher as, despite a steady reduction in the number of operational shale rigs, improved efficiency and higher payloads from the country’s most prolific fields is sending total output skywards.

And with data from commodities glutton China also continuing to disappoint — bank lending collapsed in December from the previous month, numbers showed today, and followed on from a stream of poor manufacturing releases in recent days — it doesn’t appear demand is set to pick up any time soon, either.

Dividends under pressure

Unsurprisingly the world’s oil majors seem convinced that earnings are likely to get a lot worse before they get better, with a steady appreciation in the value of the US dollar adding another lever of pressure to crude prices.

Just this week BP advised it was taking the hatchet to a further 4,000 jobs in the North Sea, the latest in a steady stream of cost reductions and capex curtailments announced in recent years. And I do not expect Shell to be far behind, either, itself also no stranger to trashing unnecessary spending plans and hiving off assets.

Still, many investors remain faithful to the oil giants thanks to the City’s exceptional dividend forecasts — for 2016 Shell and BP carry sizeable yields of 7.7% and 7.2% respectively.

But as falling revenues threaten to send earnings still lower, and the capital-intensive nature of their operations heaps massive stress on their balance sheets, I am convinced that sizeable dividend cuts can be expected that will demolish these projections.

Until the oil industry begins to get to grips with the colossal oversupply drowning their revenues outlooks, and demand indicators start to seriously pick up, I believe both BP and Shell remain far, far too risky for sensible investors.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell B. 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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