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Which is the better oil play: Royal Dutch Shell plc or Premier Oil plc?

Merry Christmas everybody, but I’m not here to talk turkey, I’m here to talk oil. The energy industry has plenty to celebrate today, as the recovery finally kicked in lifting Brent Crude to around $65 a barrel in January. This spells festive fun for an industry that has worked hard to make itself profitable at much lower prices.

Surer Shell

In 2014, oil giant Royal Dutch Shell (LSE: RDSB) needed oil trading at more than $80 a barrel to break even. Last year, its break-even point fell below $40. Cost control and a $30bn assets divestment programme have helped, with operational expenditure down 20% since 2014. Nobody is worried about Shell cutting its dividend at the moment.

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The group’s share price is up a solid 17% over the past six months and management has further cheered investors by pledging to begin paying a cash dividend again in the fourth quarter, with plans to cancel the scrip dividend programme it has been running since 2015. It remains focused on cutting debt, vital given its high debt-to-equity ratio. Free cash flow should now strengthen slightly, hitting $25bn-$30bn by 2020 with Brent crude at $60, up from $20bn-$25bn in June last year.

Going Dutch

Shell trades at a whopping 56 times earnings but that is forecast to fall to around 17.4 times, due to a massive forecast 222% increase in earnings per share (EPS) in 2017. There is rarely a bad time to buy Shell, given its long-term dividend track record, and today’s attractive 5.7% yield. Long-term investors might as well buy it today. There are even bigger yields out there, including Centrica’s whopping 8%. Here’s another FTSE 100 name I would buy and hold forever.

Premier Oil (LSE: PMO) has rebounded faster as crude recovers, up a whopping 65% in six months. With a market cap of £398m, a tiny fraction of Shell’s £92.58bn, much faster price movements are to be expected in both directions. Also, there is no dividend to see you through the tricky times.

Lower league

The big worry is Premier’s massive debt pile, which crept up from $2.7bn in June to $2.8bn in September, due to the late summer North Sea maintenance season. Chief executive Tony Durrant said it will restart debt payments from early next year, and pledged the group’s strong pipeline of projects will boost the company’s momentum. Markets were unmoved.

Premier recently agreed to sell its 30% stake in its non-core Esmond Transportation System pipeline in the North Sea to Cats Management for up to £23.6m, but there is a long way to go. It currently trades at just four times earnings. Its forecast valuation is 95.4 times earnings, which shows the level of volatility and risk you are taking on here.

Oil bull

OPEC’s drive to reduce the global glut in crude oil seems to be working, with US inventories falling by the fastest weekly rate in four months. However, Trump’s tax slashing should boost the already streamlined shale oil industry, driving fresh investment and output. Now looks like a solid time to buy and hold Shell, but you will have to be a full-on oil bull to buy Premier.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell B. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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