Shares in fossil fuel giant Shell (LSE: RDSB) have enjoyed a solid bump higher in recent days following a meaty bounce in the oil price.
Crude values have shot skywards following chatter that an accord could be struck between OPEC and Russia to curtail production. The Brent benchmark has gained $5 since Monday and is now back above $35 per barrel, reaching levels not seen since the start of January.
Shell has subsequently seen its stock price appreciate 7% during the course of the week, adding to chunky gains seen in the prior 7-day period.
But rather than pile in, I believe investors should treat this recent strength as a fresh selling opportunity as supply/demand dynamics remain in a perilous state.
Don’t expect a deal just yet
While it is true that Russia’s energy minister Alexander Novak had earlier this week floated talks with OPEC over how to support the oil price, the official has since told Bloomberg that a deal is far from a foregone conclusion.
And Novak has previously ruled out introducing domestic cuts thanks to the problems created by Russia’s harsh climate when it comes to eventually getting the pumps restarted.
This is unlikely to be the end of such political posturing as oil prices sink. Regardless, the prospect of output cuts from either Russia, OPEC or the US remains remote as the world’s major producers remain intent on maintaining market share. And political discord within OPEC itself makes the likelihood of such an accord even more unlikely.
Indeed, broker consensus suggests that the oil price has much further to fall before producers bite the bullet and introduce drastic output reductions, a necessary step as China’s flailing economy fails to ease the burden on swelling global inventories.
Brent forecasts brought down
Against this backcloth of surging supply and insipid demand, this week Edison became the latest broker to slash its forecasts. The firm’s analysts cited EIA estimates that inventory rises will not begin to reverse until the latter half of 2017.
The broker now expects Brent to average $40 per barrel in 2016, down from a prior prediction of $60. And Edison slashed next year’s forecast to $50 per barrel from $70.
Price correction on the horizon?
Despite this increasingly-bearish outlook, however, Shell is expected to bounce from a predicted 44% earnings slide in 2015 with a 7% bounce in the present period. This projection leaves the business changing hands on a P/E rating of 12.2 times.
Although this reading can hardly be considered eye-poppingly expensive, I believe Shell should be dealing on an earnings multiple of 10 times or below, the benchmark that reflects stocks with extremely high risk profiles.
A subsequent re-rating of Shell’s share price would leave the oil leviathan dealing at £12.80 per share, representing a vast 15% reduction from current levels.
But even this projection be considered optimistic, in my opinion. With earnings forecasts in danger of further downgrades, the prospect of a shocking dividend cut looming, and of course investor appetite remaining murky, I believe even heavier falls could be in the offing.
