2020 has been an ‘annus horribilis’ so far for the Royal Dutch Shell (LSE: RDSB) share price. Oil prices have collapsed on the double-whammy of both supply and demand issues. First, Saudi Arabia and Russia locked horns over supply production levels. Then the demand for oil slumped as world economies have stalled in the wake of the coronavirus outbreak.
The Shell share price has correspondingly plummeted and, despite recovering since March, still sits 50% lower than its year high.
The Shell share price is quite literally over a barrel
Shell has assumed that the average price of Brent crude will be $35 for 2020, rising to a $60 average by 2023 for its earnings estimates. But I think this is a little optimistic given the price of oil has been well below this average for much of the last five years. Ultimately, the Shell share price is intrinsically tied to the price of oil, which it cannot influence.
This lower price of oil means Shell are writing-down up to $22bn in the value of its assets. The International Energy Agency said in June that global demand for oil is set to fall at the “fastest rate in history” this year. Despite predicting a rebound in 2021, itsays with fewer people flying, it will be at least 2022 until consumption return to 2019 levels.
If in doubt, cut costs
With the Shell share price collapsing and earnings plummeting on the back of depressed oil prices, management has sensibly looked to cut costs. The highly prized dividend, not cut since World War II, was scaled back by two-thirds, and the rhetoric coming from Shell suggests there may not be a return to previous levels. However, we are still looking at a fairly decent prospective yield of 5.5% for new investors.
Shell is targeting a 20%-30% gearing range of debt to equity. Italso announced a plan to cut $3-4bn off operating costs over the next year. However, this may not be enough, and with growing impairment costs Shell might look to further asset sales to keep the books balanced. It seems the Shell share price may remain under pressure for some time to come.
The future will likely see a shift to renewables. Slashing the dividend, which previously cost $15bn each year to service, will free up funds to pivot to green energy longer-term. But this looks a very long way away right now and requires a profitable oil business to fund that change.
I say don’t be fooled by the trailing P/E ratio under eight. The forward 12 months P/E is over 20 and that is nearly double the 10-year average. Perhaps the Shell share price is not so dirt-cheap after all?
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David Barnes has no position in any of the shares mentioned. 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.