Oil’s Up 50%: Does This Mean Investors Are Safe To Buy BP plc and Royal Dutch Shell plc?

Oil bears have been left with egg on their faces as the price of Brent crude recovered by over 50% during February and March from a 12-year low of $27.50 per barrel set on 20 January.

While the price has slipped back to around $40 per barrel, investors seem to have a glimmer of hope that the world’s worst price rout is finally over. 

While there are many moving parts to the piece, I believe that the main drivers that sent the price close to $42 in Tuesday’s trading were:

  • Speculation over an imminent supply freeze led by giant producer Saudi Arabia after months of diplomatic talks
  • The tentative deal between Saudi Arabia and Russia last month where parties agreed to freeze supply at its current record levels
  • Falling production from US shale producers
  • A weaker dollar
  • Dwindling investment in the sector

All of these factors and more seem to have combined leading to hopes of a nascent rebalancing for the world’s saturated oil markets.

Is it safe to buy?

As can be seen by the chart below, both BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) have seen their share prices broadly track that of oil over the last three months as the price fluctuated. While this seems to make a certain degree of sense, to me that doesn’t quite add up. You see the oil price, along with that of many other commodities, has been on a downward trend for some time now, and at $40 per barrel for Brent crude the price sits at less than half the $100 plus per barrel that black gold used to sell for.

What’s more the shares have become more ‘expensive’. I don’t mean they’ve gone up in price. No, both shares are some way off of their 2014 highs.

What I mean is that the shares are trading on a higher multiple than before, both on a trailing and forecast view. Indeed, earnings estimates have been falling for both companies for some time now as analysts have been forced into updating their earnings projections for 2016 and 2017.

As I type, Royal Dutch Shell trades on a 12-month forecast rolling P/E of around 18 times and BP is even higher with a price tag of around 20 times earnings according to data from Stockopedia.

The Foolish bottom line

Of course the price-to-earnings multiple is just one of the ways to try to analyse whether a company is cheap, fairly priced or expensive and personally, I would be inclined to conduct further research prior to taking the plunge.

I think it’s a positive to see an increase in the oil price. However, there ‘s a lot more to be done before the current oversupply works its way through the market, and I wouldn’t be surprised to see further volatility going forward. Admittedly, due to their size and diversification, both companies will be able to ride out these events in the short term, but I would become worried if the oil price stayed this low for too long.

Personally, I would like to see at least a further 50% rise in the price of oil in order to have greater confidence that the chunky dividends currently on offer can be maintained.

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Dave Sullivan 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.