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Summary
- Shell and BP shares have dropped significantly during the first week of October with a sudden spike in Covid-19 cases
- With the onslaught of the pandemic, governments and environmental activists are pushing for lesser carbon emissions
- Shell & BP have axed nearly 20,000 jobs this year due to continuously reducing demand for crude
The coronavirus crisis has weighed down heavily on global oil major businesses, BP Plc (LON: BP.) and Royal Dutch Shell Plc (LON: RDSA). The stock prices of these two well diversified crude businesses plummeted to almost three decades low. In the last one month alone, BP shares were down by 14 per cent. This could be the right time for investors to put these stocks in their watchlist as these well-established oil giants seem too big to fail.
Potential reasons of slump in share prices of Shell and BP
The unexpected spike in active cases of Covid-19 infections across the globe has reinstated the fear in investors of demand plunge for energy. With another lockdown on cards, the anticipation of lessened demand of oil cannot be ruled out. During the first week of October, the price of Brent crude slipped below $40 per barrel. Meanwhile, oil-producing nations have been supplying oil consistently.
New coronavirus restrictions have been rolled out in Scotland, and other areas in a bid to curb the spread of Covid-19 virus and the government has insisted on following social distancing measures religiously.
With the onslaught of the pandemic, governments and environmental activists are pushing for lesser carbon emissions. Oil majors across the world are under pressure to make a swift transition to cleaner energy sources while maintaining profitability for their respective shareholders. BP has joined forces with the Norwegian state oil company, Equinor, to develop offshore wind projects in the US.
Shell’s shares nearly dropped to 3-decade low prices after it declared to make 9 thousand jobs redundant. In order to fuel, renewable energy development, BP and Shell have axed nearly 20 thousand jobs so far (in 2020). To reduce costs further, Shell has unusually slashed dividends, and BP has reduced its capital expenditure by nearly one-fourth.
Also read: FTSE 100 crosses 6000: Rally in BP, Shell, and Rolls Royce share prices
Oil market Mechanics
The price of oil is determined by three main factors: Supply, Demand, and Costs related to drilling & production. When demand is low, and supply is high, the prices of oil tend to decrease, which is exactly what has happened during the crisis induced by the coronavirus pandemic.
During the initial part of the year, when the world was put into lockdown and people were forced to stay at home, which meant people would drive less and would not fill up their cars as they used to do in pre-pandemic times. Thus, the consumption of oil dropped massively. The aviation sector also saw a massive decrease in oil demand. As the skies were closed due to travel bans, most of the air carriers were grounded during the unprecedented crisis.
However, the economies have started to recover, and coronavirus cases around the world have also been stabilising, the oil demand is expected to increase as we transcend 2020. The main industry which would propel the demand for oil upwards through 2021 is aviation.
Also read: Oil Demand Outlook Stays Weak: Focus On BP, RDSA, And TLW
Moreover, the electric vehicle market is in the nascent stage, and the conventional engines are still cheaper than electric vehicles. As people begin to drive their cars, the demand for oil is likely to increase in the near term. Same applies to large trucking companies and other transport vehicles.
Even though the economies have gradually reopened, and people have started to drive again, the aviation industry is still undergoing tough times and is yet to pick up the pace. According to the International Air Transport Association, the trade association, passenger traffic has dropped drastically in 2020 in contrast to the previous year. These factors have contributed to the lessened demand for oil. Alternatively, the supply of oil has been consistent. Higher supply and lower demand for oil have pushed down oil prices.
Is there a divergence in play?
Not exactly, as divergence is a situation which arises with sellers looking for buyers or the place for storing physical crude. However, there might be a lag in the valuation of oil stocks which are moderately correlated with the oil prices. The price of oil has a direct impact on the profitability of the oil companies as they realise their revenue streams on per barrel of oil produced; this is how they derive their cash flow and earnings.
Alternatively, oil prices might also influence the oil producing companies. If the cost related to drilling & extraction is much higher than the price of oil, the oil producer might slide into losses. As the industry evolved, the oil companies have strategically diversified their asset portfolio to hedge against oil price volatility. However, a prolonged lockdown can severely put these FTSE 100 oil companies in a tight spot.
Also read: BP and Shell share prices at 25-year low: Does this call for investment in oil stocks?
Oil prices witnessed yet another low during the first week of October with Brent Crude clocking a price of just under US$ 40 per barrel. However, industry experts believe that crude prices shall rise significantly in 2021. As the crude is expected to rise in 2021 and it is trading at a comparatively low cost right now, then could this be a great opportunity for value investors? Now, this low price in oil could mean an opportunity to get good value in some oil stocks, as volatility also means a window of opportunity for many investors. The UK currently looks forward to an ambitious trade deal with the EU and a favourable stimulus package from the United States.
