Analysts have always assured us that large vertically integrated oil majors are more than just a play on fossil fuel prices. The collapse in the oil price over the last year, and the parallel collapse in their share prices, has now eroded that comforting illusion.
One year ago, Brent crude was trading at around $100 a barrel. Today, you can buy a barrel for just $50. Over the same period, the share prices of BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) suffered similarly catastrophic falls off 26% and 35% respectively.
Futures Shock
This works in the other direction, too. When oil futures leapt 8% on Monday, BP and Shell suddenly recouped 3-4% of their share price losses. Where oil leads, the FTSE 100-listed majors broadly follow. So the big question overhanging both these stocks is still this: where does oil go next?
The clouds hanging over the sector suddenly lifted earlier this week, with oil enjoying its largest three-day surge since 1990, rising more than 25%, or around $10 a barrel. It was beginning to look like somebody had fired the starting gun on a bull market in oil.
The surge was partly fuelled by rumours that OPEC was open to talks on cutting supplies, allied to reports that US first-half oil production had been overestimated by 250,000 barrels per day (bpd), and revised downwards to 9.3m bpd. Oil has flattened again. The short-lived spike now looks like yet more market volatility, one of Black Monday’s many after-shocks, rather than anything substantial.
Selling It Short
Such a rapid move upwards also invites suspicions. It was almost certainly fuelled by short traders covering their positions after betting heavily that oil would fall further. As short-term volatility calms, markets will focus more on underlying long-term economic factors, and they don’t look so hot right now.
The oil price may have leapt 25% but demand from China certainly hasn’t. The authorities are so rattled by the country’s slowing economy they have taken to arresting scores journalists and financial executives. Manufacturing PMI figures are in retreat everywhere, including the UK, as global trade slides. US jobless numbers are up. OPEC didn’t agree to cut production. US frackers are more resilient than anticipated, aided by plunging drilling costs. If oil rises again they will quickly ramp up their activities, capping any increase. Russia is pumping oil, even at a loss. Iran is on the way to market, if Congress approves the recent nuclear deal.
Over A Barrel
Think carefully before rushing back into BP and Shell, because they continue to have a long and hard road ahead of them. Talk of an oil bull market is dangerously cheap. Both stocks do look tempting, given recent share price falls and their stonking yields of around 7%, which should be good for another year or so, even at today’s low oil prices. But you have to accept that oil could fall again, and if it does, BP and Shell’s share prices will surely follow.