Financial Times: Oil stocks are back in vogue: “BP shares are up 22.3 per cent this year, while Shell's have climbed only 1.5 per cent. The former has outperformed the latter for a number of reasons. Shell is still recovering from the disclosure that forced it to cut 20 per cent from its proved reserves earlier this year. Its image as slow-moving, bureaucratic and conservative continues to haunt it.” (ShellNews.net)
By Christopher Brown-Humes
Posted 9 Oct 04
Deeply unloved at the beginning of the year, oil stocks are today the fashion of the moment. BP, the biggest company on the UK stock exchange by market capitalisation, this week reached a 27-month high. With oil prices hitting record highs, as they did again this week as Brent oil prices neared $50 per barrel, none of this is surprising.
Indeed, the strong performance of oil companies is one of the main reasons why the FTSE 100 has outperformed many other leading stock markets this year. BP alone accounts for 10.6 per cent of the FTSE 100 market capitalisation and oil stocks in general (adding Shell, BG group and Cairn Energy) make up 15.5 per cent. Every penny rise in the BP share price adds almost one point to the FTSE 100 (0.89 to be precise). And every $1 increase in the cost of a barrel of Brent oil, all else being equal, adds $570m to the oil giant's full-year profits.
BP shares are up 22.3 per cent this year, while Shell's have climbed only 1.5 per cent. The former has outperformed the latter for a number of reasons. Shell is still recovering from the disclosure that forced it to cut 20 per cent from its proved reserves earlier this year. Its image as slow-moving, bureaucratic and conservative continues to haunt it.
At the same time, the two companies have different production profiles. BP lifted daily production by 11 per cent in the third quarter to 3.9m barrels of oil equivalent and it expects its average production for the year to exceed 4m boe, 10 per cent more than last year. Shell expects its production to be broadly flat over the next five years.
The fact remains that while the oil price has climbed more than 60 per cent this year, the shares of both BP and Shell have climbed by a much smaller amount. The reason the two are out of sync is simple. Very few people believe that oil prices are going to stay at their current high levels.
Angus McPhail, oils analyst at ING Financial Markets, said: “There's a perception that we have something like an oil price bubble, just as we had the dotcom boom a few years ago.
“People forget the fundamentals: a high oil price will drive supplies higher and demand will fall. A high oil price creates the seeds of its own destruction.”
Having said that, expectations for average oil prices are moving up. Morgan Stanley this week predicted that the average price of Brent oil next year would be $34.50 a barrel, compared with an earlier forecast of $25. It also increased its forecast for the longer-term average oil price to $30 a barrel from $25. Even ING expects an average price for Brent next year of $36 a barrel, falling to $32 in 2006 and $28 in 2007.
The question for private investors is whether they should be increasing their exposure to oil stocks or trimming their portfolios on the back of the good run they have enjoyed this year.
One factor to consider is risk profile. Increasingly, the growth prospects of the oil majors will depend on them extracting more oil from more politically risky and inhospitable parts of the world.
BP now derives a substantial part of its production from Russia after agreeing a joint venture with TNK last year. So far its purchase looks very shrewdly timed. But it won't look so clever if President Putin's increasingly authoritarian regime decides to come down hard on other oil groups apart from Yukos or if Russian taxation or regulation changes arbitrarily. Shell faces its own risks in Nigeria, as strikes in that country showed this week. There is also yield to consider.
BP has been buying back its own shares aggressively and is set to continue doing so. Mr McPhail forecasts that the company's cash return yield (the impact of share buy-backs and dividends together) will be 6.3 per cent this year and 6.1 per cent next year. In other words, better than the best paying cash deposit account on the High Street.
It's a different picture at Shell, where he estimates the cash return yield will fall to 4.0 per cent next year from 5.3 per cent in 2004. There is a great deal of uncertainty about whether Shell will continue to buy back its shares: the whole thrust of its recent strategic presentation was that it was going to increase capital spending to achieve higher production levels after 2009.
In any case, investors should take some comfort from the following: the fact that oil shares have not over-reacted when the oil price is surging upwards should mean that they do not plummet when prices fall back again.