The last decade has been a rollercoaster ride for investors in the oil and gas industry. Just under ten years ago, the oil price peaked at $158 per barrel before falling sharply to trade at less than one-third of that level. A recovery in the period 2009-2014 was undone by a glut of supply. This pushed the price of oil to its lowest level of the century, with it changing hands at less than $30 per barrel in early 2016.
Today, its price stands at around $65 per barrel following a recovery, and its future prospects appear to be relatively bright. While volatility is unlikely to have been made redundant, the prospects for oil majors BP (LON:BP) and Shell (LON:RDSB) appear to be positive.
While accurately predicting short-term movements in the oil price is very challenging, the outlook for the commodity appears to be upbeat in the current year. According to the International Energy Agency (IEA), the balance between demand and supply is set to be relatively stable this year. Demand growth is expected to outstrip supply growth as the year progresses, with production cuts from OPEC members coupled with continued growth in the global economy set to have a generally positive impact on the oil price.
Of course, there are a number of variables which could change as the year progresses. One of them is the continued increase in supply from US producers. The US is expected to surpass Saudi Arabia in a matter of months when it comes to crude output. And by the end of the year there is a reasonable chance that it will overtake Russia to become the global leader. This could have a negative impact on prices, but may be offset to some degree by further declines in production from OPEC members should the price of oil come under pressure.
With the outlook for oil being positive but still uncertain, oil majors such as BP and Shell continue to trade on relatively low valuations. In spite of the rise in the oil price in recent months and the potential for higher profitability, BP has a prospective P/E ratio of 14.9 and Shell’s prospective P/E ratio is 13.5. Neither of these ratings seems to be particularly demanding when EPS growth of 7-10% is forecast for both stocks in 2019.
As well as capital growth prospects from a higher rating and a rising price of oil, the two companies offer high income return potential. They yield 6-6.1% and, crucially, in the current year their dividend payments are forecast to be fully covered by profit. This indicates that their current level of payouts are not only sustainable, but could increase at a faster pace than inflation over the medium term.
Clearly, neither stock offers defensive characteristics due to the potential for changes in the outlook for the oil price. However, with high yields, fair valuations and improving profitability, they seem to have high potential rewards.
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