Last week wasn’t great for big oil. Neither BP nor Royal Dutch Shell impressed with their latest results – Shell’s profits were down 76% on last year. Both stocks are down more than 10% from their early- January peaks. Indeed, given both offer 6% yields, they now look cheap. So what’s upsetting the oil market and are these stocks still a good way to make money?
Global crude oil volumes dropped by 1.5% last year, the largest fall since the 1980s, according to the International Energy Agency (IEA). And although the key West Texas Intermediate (WTI) benchmark recovered from 2009’s average of $62/barrel to around $82/barrel at the start of this year, it has since dipped to around $70/barrel.
In part this is due to fears about global growth when government stimulus schemes wind down, prompting demand worries. Market jitters over Greece and big downward revisions to American job numbers haven’t helped either. As oil is quoted in dollars, recent strength in the US currency has automatically lowered crude prices.
Meanwhile oil price forecasts, as ever, vary widely. The US Energy Information Administration (EIA) sees WTI averaging almost $80/barrel in 2010 and predicts $83.50/barrel for 2011. But that’s based on an upbeat economic growth forecast of 2.7% in 2011 for Organisation for Economic Cooperation and Development (OECD) countries, which “should begin to show significant oil demand growth in 2011 in response to improving conditions”. And there are several other caveats. “Compliance with cuts announced by the Organisation of the Petroleum Exporting Countries (Opec) has weakened,” warns the EIA. Meanwhile, “global oil inventories and spare production capacity remain very high by historical standards”. In other words, there’s still lots of oil around – and plenty of scope for prices to drop if economic growth doesn’t come through.
Also, greater fuel efficiency and the use of alternatives mean OECD countries’ oil use – likely to be 53% of world demand in 2010 – will never return to 2006 and 2007 levels, the IEA’s Dr Fatih Birol tells Reuters. World demand for 2010 is forecast to be 86.3 million barrels per day (mbpd), up from 84.9 mbpd in 2009, but that will be due to Asian growth. “None of us will sell more gasoline than we sold in 2007,” says BP boss Tony Hayward.
He says that’s “being offset by very strong... markets of the East, and particularly China”. But petrol is actually the main problem for BP and Shell. Both were hit by large losses in their downstream (oil refining) divisions. That’s because “there are too many oil refineries in North America and Europe”, says Nils Pratley in The Guardian. This “is killing everybody’s profit margins”. Nor is a near-term upturn likely. The downstream and chemical areas will be particularly tough in 2010, says Shell CEO Peter Voser. Add in the need to maintain capital spending to secure future crude supplies, and the oil giants’ cash flows will be squeezed further. Both firms are now having to borrow to fund their dividends. That’s raising questions about how safe their high dividend payouts are.
Yet, for all these worries, while oil prices stay above $60/barrel, we don’t see too much danger of a dividend cut from either firm. Last year, with banks no longer paying out what they used to, BP’s and Shell’s dividends accounted for 25% of the overall distribution by UKlisted companies. Shareholder pressure to maintain payments will be intense. But if you want a way of making money from the oil business – with the prospect of an even better yield than big oil.
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