Last week was an extraordinary one for oil companies. Not only are they dealing with the ongoing operational issues associated with coronavirus, but the price of oil fell below zero for the first time ever. So, why am I bullish on the Shell (LSE: RDSB) share price? Three key reasons are explained below.
Impact of global oil demand on the Shell share price
Low global demand and declining storage capacity were two key factors in last week’s crash. Quickly, here are the technicalities.
Many of the players in the oil market are speculators, looking to profit from price movements. One way to do this is to use futures contracts. This is an agreement between two parties to exchange barrels of oil at a fixed price and date in the future. However, most speculators don’t want to physically receive that barrel of oil. Therefore, they sell the contract before that fixed date is reached.
Unfortunately for such speculators last week, the oil price rebound they had bet on did not occur; they had run out of time. Desperately, they then tried to sell their positions to avoid taking physical delivery. This is currently expensive as there is limited storage due to over-production, so they were willing to accept the losses and the price of these contracts crashed.
Why does any of this matter in the long term for Shell? In my opinion, it doesn’t. The Shell share price actually finished up last week. Whilst it is possible another price crash could occur in the following months, I believe global demand will rebound once lockdowns lift. Fossil fuels still account for 80% of the world’s energy source. Therefore, an increase in demand is good for Shell.
Of course, low oil prices are bad for the Shell share price. In a recent statement, it mentioned that each $10 price-per-barrel decrease in Brent oil costs them $6bn a year. With Brent crude at its lowest level in decades, this will hurt the short-term profits of the company. This is a lot of money, but note that Shell’s operating profits were $23bn in 2019.
It is also worth noting that oil prices have been so low due to the Saudi Arabia-Russia price war, resulting in over-production. However, two weeks ago a truce was called and the OPEC alliance have agreed to slash production. I believe that when global oil demand returns, this will help the oil price rebound and be beneficial to the Shell share price.
However, for Shell to benefit from an oil price rebound, it actually needs to be around. Therefore, having the liquidity required to survive until this point is crucial. Well, Shell has recently secured two credit facilities worth $22bn to add to the $20bn of cash it already has.
Therefore, whilst I think the short-term outlook for the Shell share price is uncertain, at a price-to-earnings ratio of 8.8 (BP’s is 20), it is still a long-term bargain. Additionally, its latest dividend yield is 10.27% and therefore also an income play.
Charlie Watson does not own shares in Royal Dutch Shell. 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.