Saudi Arabia is countering Russia’s refusal to decrease production by swamping oil markets with discounted Saudi crude. Oil producers are suffering the fallout with reduced revenues that threaten profits.
Bleak outlook for oil
The short-term outlook for oil markets is bleak, and many analysts believe that prices will remain under pressure.
As of 9th March, Brent Crude and West Texas Intermediate – the two oil benchmarks – were trading for $35 and $33 per barrel respectively. For perspective, the benchmarks were trading at an average of $64 and $57 per barrel throughout 2019.
To make matters worse, lower travel and industrial activity are reducing oil imports into China. BP’s CFO has warned that the outbreak of COVID-19 alone could knock 0.5% off oil demand this year. And if geopolitical tensions continue, this will likely get worse.
To understand the possible impact on the shares of FTSE 100 oil producers, I think it’s worth looking at how and why markets previously reacted to the decline in 2019 profits for BP and Shell.
Declining revenues for FTSE 100 oil majors
Both FTSE 100 companies saw a large drop in profits in 2019, mainly due to lower oil prices than previous years. However, BP’s share price remained steady around 470p after its results were released in early February 2020. Shell’s share price continued to slide from a January pre-result peak of around 2,300p.
Throughout 2019, I believe BP showed a more resilient financial performance than Shell. BP’s revenues fell 7% compared with Shell’s 11%. BP stated that its industry metric, the underlying replacement cost profit, nosedived 21% to $10 billion. Shell’s equivalent measure, the current cost of supplies, plummeted 23% to $16.5 billion.
BP and Shell have both made costly purchases. BP bought US shale assets from BHP Group in 2018 for $10.5 billion, and Shell purchased BG Group for $50 billion in 2016. Both FTSE 100 firms increased their debt to do so. However, both companies maintained their gearing ratios between 29 and 31%, within normal range for the industry.
Also, in BP’s favour is the lower breakeven cost of $53 per barrel, compared with Shell’s $65 per barrel. This potentially leaves BP in a stronger position through an oil glut.
Juicy dividend yields
Despite lower revenues, BP’s 2019 was able to fund its capital expenditure, pay dividends and complete its share buyback programme. This allows the firm to use future cashflows for its 8% adjusted dividend yield, to pay debt or for investment purposes.
Shell’s position is more uncertain as its cashflow struggled to cover its costs in 2019. Going forward, many analysts believe it is unlikely to return to investors the remaining $10 billion in its buyback programme. But it appears to be a common consensus that Shell will likely maintain its juicy 9% adjusted dividend yield.
BP is currently trading at a price-to-earnings ratio of 21.1, while Shell appears to be going cheap at around 8.9. BP is in normal industry range, reflecting its more assured position moving forward. Short term, Shell is a riskier investment. But for those with a longer term or income focus, it could be a timely one.
It’s ugly out there…
The threat posed by the coronavirus outbreak has spooked global markets, sending stock prices reeling.
And with the Covid-19 virus now beginning to spread beyond of China and Italy, it seems very likely that the bull market we’ve enjoyed over the past decade could finally be coming to an end.
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Rachael FitzGerald-Finch owns shares in Royal Dutch Shell and BP. The Motley Fool UK has no position in any of the shares mentioned. 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.