The price of oil just keeps falling! It’s not so surprising, though, given that the underlying dynamics of the market haven’t changed (supply glut and falling global demand), but it’s still an impressive fall. Brent crude has now dropped around 50% since July.
So where does that leave those poor old oil producers?
Already cutting back
It didn’t take long but the world’s major oil producers have started to shed layers as it heats up in the oil and gas market. Royal Dutch Shell (LSE: RDSB)’s latest move is arguably one of the more significant to date. The oil company announced earlier in the week it’s going to ditch its $6.5 billion Qatar project. The Al-Karaana petrochemicals project in Qatar has been deemed uneconomical due to high capital costs. ‘Pointy heads’ often use the Capital Asset Pricing Model (CAPM) to determine if an investment is worth undertaking — that is, do the risks outweigh the returns? Something similar will have been used by the finance team at Shell for this little project… and the end result was a thumbs down.
Is BP a better way to gain exposure to oil?
I’d like to think of BP as an alternative way to gain exposure to the price of oil, but it too is suffering the effects of the bear market. In fact just this week BP (LSE: BP) (NYSE: BP.US) and ConocoPhillips announced they too would be shedding 500 jobs between them in the North Sea. Specifically, BP said it was going to cut 200 onshore staff, and 100 contractors. To save face, BP said that it was all part of a $1 billion restructuring plan announced late last year.
What do the ‘experts’ say?
United-ICAP has been quoted by Reuters saying that the little price spike we had in the middle of this week may have just been “a blip”. In other words — those guys are still bearish on the oil price. Bank of America Merrill Lynch has also been quoted as saying Brent could go as low as $31 per barrel by the end of March this year.
Even the Organization of the Petroleum Exporting Countries (OPEC) has forecast demand for the group’s oil will drop to 28.78 million barrels per day this year. That’s down by 140,000 barrels from its previous estimate. Indeed, official US inventory data released earlier this week show total US crude oil and petrol product supplies at a record high. That all sounds pretty bearish to me, and potentially negative for both comapnies.
According to the Carbon Tracker Initiative, a significant proportion of Shell’s potential future production requires a market price of around $95 per barrel (+/- $15). It’s natural to assume therefore that the oil giant will keep cutting back on its capital expenditure. That will help to at least stem the outflow of cash from Shell but won’t improve the company’s financial position.
What does the market have to say?
Interestingly, the stock prices of both BP and Royal Dutch Shell rallied on Thursday. That’s the market’s way of saying, ‘we think you’re doing the right thing by pulling back a bit’.
In the short term, remember that the bigger you are the harder you fall. So a falling oil price is — at the margin — going to look worse for Shell (bigger cost-cuts and bigger lay-offs) as time goes on.
So what about for investors with a slightly longer time horizon? Well, if you look at some basic fundamentals, the picture becomes a little clearer. Both companies have a similar profit margin of around 4% (made worse by the falling oil price). BP though is sitting on a price-to earnings multiple of 11 times earnings and is yielding a 6-7% dividend return. Not bad. Shell’s dividend is also attractive at a little under 6%, with a P/E of around 12.
The bottom line? This Fool doesn’t think now is the right time to get back into oil stocks (either BP or Shell). When that time does come, however, both stocks will look “cheap”.