After a handful of years of relative stability, 2014 has seen the price of oil fall by around a quarter. Indeed, as a result of stalling demand and increased supply, the oil price has tumbled throughout the course of the year. Perhaps more importantly, though, the oil price is showing little sign of reversing its recent trend in the near future, as Saudi Arabia maintains current supply levels so as to keep hold of its dominant market share.
The knock-on effect of a lower oil price is weaker results for oil producers and oil services companies. With oil services company Petrofac (LSE: PFC) today downgrading its outlook for 2014 and 2015, could oil producers such as Shell (LSE: RDSB) and BP (LSE: BP) be next?
Downbeat Expectations
In today’s release, Petrofac states that, while its expectations for 2014 are still within its previous guidance range (albeit at the lower end), it anticipates that results for 2015 will miss its previous targets. The key reasons for this are a lower oil price environment, an expected final commercial settlement in respect of the Laggan-Tormore project in Shetland resulting in no profit or loss being recognised in 2015 on the project, as well as changes in the company’s view of costs and the timing of first oil in respect of the Greater Stella Area project in the North Sea.
As a result, net profit for 2015 is expected to be around $500 million, which is a quarter lower than previous guidance. As such, shares in Petrofac have fallen by 23% on the day and are now down 25% during the course of 2014.
Looking Ahead
Of course, only part of the profit warning from Petrofac is due to a lower oil price, with the delivery of projects missing forecasts being the other major reason. As such, shares in the company have perhaps been hit harder than if the profit warning was due solely to external factors, as investors seem to be of the view that poor project delivery could signal additional challenges in future for the business. Therefore, sentiment in Petrofac could remain weak in the short run, as investors wait for proof that the company’s project delivery is back on-track.
Read Across For BP And Shell
Clearly, a lower oil price is bad news for oil producers such as BP and Shell. However, today’s update from Petrofac does not provide particular insight for either company, since the majority of Petrofac’s challenges are internal, rather than external, and a lower oil price is already arguably being factored in to medium term forecasts for the two oil producers.
Therefore, shares in BP and Shell are currently trading in-line with the market thus far today. And, with both stocks offering yields of 5.4% (BP) and 4.9% (Shell) and trading on price to earnings (P/E) ratios of just 10.4 and 10.6 respectively, they still seem to offer excellent income and value potential even if the oil price stays relatively low over the medium term. More importantly, though, their share prices offer a margin of safety so that, even if downgrades to profit guidance are forthcoming, they may not be hit as hard as you may expect.
As for Petrofac, investors will need to see evidence of improved project delivery before sentiment picks up. With shares in the company trading on a P/E ratio of around 9, however, they could still prove to be a strong long-term buy.