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Is OPEC’s Output Deal A Game Changer For Royal Dutch Shell And BP?

Is OPEC’s Output Deal A Game Changer For Royal Dutch Shell And BP?

Royston Wild: Sept 29, 2016

Investors in the fossil fuel sector have finally had cause to celebrate this week after OPEC suggested that an output freeze could finally be in the offing.

The idea had initially been tabled at the start of the year as Saudi Arabia, Qatar, Venezuela and Russia got around the table. But Iran’s determination to get the pumps ramped back up to pre-sanction levels put the plan firmly on the backburner.

However, with Tehran’s reluctance to take part in a deal now apparently thawing, stock pickers have become more optimistic over the growth outlook for many of the oil industry’s major players.

BP has seen its share price leap 4% in Thursday trading, for example, taking the firm to four-month peaks around 450p per share. And a 6% rise at Royal Dutch Shell ngIf: ticker has taken the driller to within a shade of the £20 marker.

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But are stock pickers piling in too early?

Saudi Saves?

Any suggestions that OPEC — a body responsible for around 40% of total global supply — could be about to curb production should be greeted with fanfare.

Led by the Saudis, the cartel this week informally agreed at Algiers to reduce output from 32.5m-33m barrels of oil equivalent per day, down from around 33.24m barrels at present. The next step will see policymakers designate cuts for each member state in the run-up to November’s official meeting.

Still, some friction may occur during the course of ‘divvying up’ each nation’s output. As UBS points out, although Iran as apparently agreed to cut its target to 4m barrels per day from 4.2 previously, problems may well appear elsewhere — indeed, the broker notes that “it is unclear if any limits will be placed on Iraq and Libya’s attempts to ramp up production.”

UBS believes that global inventories would fall by 400,000 barrels per day during the first half of 2017 should OPEC’s ceiling materialise, before accelerating to 600,000 barrels in the second half and 1m barrels in 2018.

But UBS remains uncertain over the oil price outlook looking ahead, its analysts citing “uncertainty [that] quota allocations by country don’t lead to a breakdown in the agreement (or cheating),” and “concerns that a quick rally into the $50s will only serve to incentivise further increases in US drilling activity and stimulate earlier than necessary production growth.”

Supply Surging

Indeed, the oil market’s severe supply overhang could be set to persist regardless of OPEC’s actions in the weeks ahead.

Latest Baker Hughes data showed the US rig count rise for the 12th week out of the past 13, with 418 drills now in operation. And Bloomberg recently reported that Russia has pumped an average of 11.1m barrels per day in September, levels not seen since the dissolution of the Soviet Union.

Clearly hopes of a significant earnings bounceback at either BP or Shell are built on very sandy foundations.

And with the oil giants dealing on elevated forward P/E ratings of 35.7 times and 26.4 times respectively — sailing above the FTSE 100 average of 15 times — I believe the risks associated with both firms continue to outweigh the possible rewards.

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