It’s been a shocking start to the year for global stock markets in general and the oil price in particular. A barrel of Brent crude has fallen to a 12-year low of $34 and there’s no sign of it bottoming out. That’s astonishing as you might have expected the opposite to happen, given soaring tensions between Saudi Arabia and Iran, the world’s largest and fourth-biggest oil producers, respectively.
Glut of black gold
Geopolitical troubles could easily trigger an oil shock that could send the price spiralling upwards as fast as it has fallen. Yet markets can’t bring themselves to think about that prospect with the world swimming in an absolute glut of the black stuff.
When the oil price falls, even vertically-integrated oil majors like Royal Dutch Shell (LSE: RDSB) fall with it. Shell is down 30% in the last year and 4% so far in 2016. Smaller explorers such as Premier Oil (LSE: PMO) have it even harder. Its share price is down 76% over 12 months, and a shocking 24% in the last week. Both are having a tough time, and times may get tougher.
BG or not BG?
Management at Shell has the further issue of integrating recent acquisition BG Group in a deal that has many critics. Ian McVeigh at fund manager Jupiter has likened it to Royal Bank of Scotland’s disastrous takeover of ABN Amro just before the financial crisis. This week institutional investor Capital Group, which also holds a sizeable Shell stake, has more-than-halved its holding in BG from 2.2% to 0.9% in protest.
Shell now yields an astonishing 8.22% but it’s hard to see how this can be sustained for much longer with the oil price sinking and profits plunging. We’ve seen too many dividends fall over the last year to be shocked by the notion that Shell will have to cut as well, despite its cherished record of never having done so since the war.
Premier plunge
Premier is likely to post a £110m pre-tax loss for last year, although optimistic forecasts suggest this should convert into a £38m profit in 2016. But investors are right to be running scared right now, as Premier’s forecast debt total of $2.7bn is based on the fantasy price of oil at $58 a barrel. While Premier can survive 2016, its share price will suffer at the hands of plunging sentiment.
Worryingly, the oil price could drop further as Iran is likely to pump with abandon once sanctions are lifted. Iran’s economy is more diversified than Saudi’s, which draws 80% of its revenues from petrol, and it calculates that its pain threshold is far higher. Saudi seems to be making the same calculation: one of them will be wrong. If tensions rose even higher and Iran threatened oil supplies through the Straits of Hormuz, the sky would be the limit for the oil price.
Also, plunging oil investment will eventually hit supply. Oslo-based consultancy Rystad Energy forecasts that worldwide oil and gas investments will slide to a six-year low of $522bn this year, following their 22% fall to $595bn last year. At some point, oil has to recover. But even that may not be enough to save Shell and Premier. US shale is the new swing producer, that could limit future price rises to $50 or $60.
2016 will be a tough year for Shell and Premier, and the longer-term outlook is troubling too.
