On Monday, US crude oil prices fell below $20 a barrel, to their lowest level in 18 years. With the collapse in demand caused by the coronavirus pandemic, production may soon have to close down.
The Financial Times reported that the global oil industry is facing its biggest demand drop in history. Analysts are forecasting that crude consumption could fall by as much as a quarter next month. This comes in light of widespread lockdowns around the world.
But what does this mean for the oil companies listed in the FTSE 100? Let’s take a look at whether or not shares in BP (LSE: BP) or Royal Dutch Shell (LSE: RDSA) represent a good investment.
An unhealthy surplus
On top of the shrinking demand for oil caused by the global pandemic, the price war between Russia and Saudi Arabia adds to the dilemma.
As a result of the disagreement between OPEC and Russia over proposed production cuts, Saudi Arabia has now pledged to increase supply and raise exports.
A surplus leads to one thing – a decrease in price. Be under no illusion, lower oil prices are a good thing for everyday consumers. However, what are the implications for UK oil companies?
BP
As with every company in the sector, BP’s share price remains largely reliant on the behaviour of oil prices. Therefore, in light of recent events, the share price plummeted by around 50% in the stock market crash.
Since then it has staged an impressive bounce back, climbing by around 40% in the last two weeks. However, this still leaves the company’s share price down by 32% on the start of the year.
Despite fourth-quarter underlying profits falling 26.2% to $2.6bn, the group announced a 2.4% increase in quarterly dividend to 10.5 cents per share. The group made an underlying profit of $10bn in 2019 and operating cash flow was a strong $26bn for the year.
What’s more, in a recent annual report, bosses stated that BP’s “global operating structure and long time-horizons are intended to mitigate the effect of near-term shocks”.
All in all, BP is a solid company. That said, I’d keep in mind the potential impacts of sustained lower oil prices and weak demand on the company, which could result in dividends being scrapped.
However, I’m confident that, so long as the company maintains a strong balance sheet and healthy cash flows, it can weather the storm.
Royal Dutch Shell
Royal Dutch Shell’s share price has almost perfectly mirrored BP’s. An initial 60% drop was swiftly followed by a 37% bounce back in the last two weeks. This leaves the share price down by around 44% on the year.
A price-to-earnings ratio of 5.55 suggests there’s value to be had. But dismal full-year results show that performance in 2019 was relatively poor. Income for the year was down by around 45%, which concerns me in light of the current economic outlook.
That said, blue-chip giants such as Shell and BP are better placed than smaller rivals. The hit to earnings will be crippling, but I think Shell has the cash reserves and balance sheet to survive.
Oil prices will, eventually, begin to rise. Lockdown measures will be lifted and the world economy will grope towards a degree of post-pandemic normality.
When that time comes, oil giants such as BP and Shell may be well placed to deliver favourable returns to investors.
