Investors have been selling Shell (LSE: RDSB) shares in large numbers this year. It’s easy to see why.
The pandemic has severely impacted the demand for oil and gas around the world. Indeed, at one point earlier this year, the outlook for oil demand was so dire that producers had to pay traders to take the product for the first time ever.
No company in the oil sector has been able to escape the pain of crumbling prices. Shell revealed a multi-billion dollar asset write-off in the first half of the year thanks to the slump. The group was forced to slash its dividend for the first time since the Second World War.
As the company’s outlook darkened, Shell shares crumbled. At the end of October, the stock dropped below 900p, its lowest level this millennium.
However, in the past few weeks, the group’s outlook has started to improve. As oil demand has recovered, oil prices have begun to recover too, and this has had a positive impact on Shell shares. And I think this could be just the start of a much bigger move higher by the stock.
Shell shares look cheap
Shell’s outlook is tied to the fortunes of the oil market. Analysts expect the market to recover most of the ground it lost in 2020 by 2021. Of course, this isn’t a given. A third or fourth wave of coronavirus could hold back the recovery. Output growth may also push down prices if supply exceeds demand.
Still, I believe the worst is behind the market. The world is adapting to the new normal. Lockdowns are no longer as severe as they were the first time around, and people are getting used to living with the virus. Recent vaccine news has also ignited hopes that the world can move on in the next 12 months.
All of the above suggests to me that the oil price may not return to recent lows any time soon. That’s positive for Shell shares. The company could see a double benefit from rising oil prices. Not only will the group be able to sell its output at a higher price, but it should also benefit from improved profit margins.
Over the past 12 months, the oil major has tried to slash costs to remain competitive. I reckon this will help the group generate more profit per barrel produced even at lower prices.
Management seems to agree with my optimistic outlook. The company recently announced a small dividend increase and a return to its progressive dividend policy, whereby the payout is increased by a small percentage every year.
A return to 2,000p?
All of the above suggests to me that Shell shares may continue their recovery over the next 12 to 24 months. If the price of oil continues to recover, the stock may even return to the level at which it began the year, although that is a big IF considering the outlook for the global economy.
Nevertheless, as the state of the oil market continues to improve, I’m considering buying more shares for my portfolio.
Rupert Hargreaves owns shares in Royal Dutch Shell B. 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.