“Congratulations for predicting lower oil prices for so long. Hats off to both of you. If I remember correctly Shell is still one of your top ten holdings. In view of this recent correction, and lower oil prices, I wonder if you favour Shell or other oil company shares?”

David Fuller's view

Thanks for your comment and interesting question.

My often repeated long-term forecast for crude oil was that it would be lower in real terms in the latter years of this decade, so I am as surprised as anyone else by the speed of this recent decline, which is now very overextended.  Friday’s decline looks climactic and following new lows today, we saw the first real indication of new demand since $115 in June.

It is most definitely a supply rather than demand shock and the Saudis are trying to knock out US shale.  They are also trying to preserve market share.  This is a risky, perhaps even desperate strategy because time is no longer on the side of any economies which are primarily oil exporters.  Moreover, many of these have large deficits, so their stock markets and currencies are in freefall.  Russia is the classic example as the RTSI$ fell to new lows today, while the Ruble (shown inversely against the US Dollar), weakened to well below $50 this morning, before reducing today’s loss as oil prices steadied after new lows.

As for oil shares, the slump in crude is obviously a headwind which can only lower profits for the best of the majors, including Royal Dutch Shell (B).  I bought this share in 2010, for income and some capital appreciation, not long after BP’s Deepwater Horizon drilling rig exploded in the Gulf of Mexico.  It paid a dividend of over 5% at the time and I have also added to my initial position on some of the setbacks which raised the yield above 5%, as is the case today. 

My feeling is that since RDS announced in July 2013 that Ben van Beurden, the previous director of refining and marketing operations, would succeed the retiring Peter Voser as chief executive on January 1^st 2014, we have seen a much more efficient management of this oil major.  If his continued policy is to favour shareholders, as I think it may be, and if you think oil will bounce back to $100 within six months, then Shell is clearly a buy today.  One could say the same for US oil majors.

However, I am uncertain because so much depends on what the Saudis do over the next several months.  For instance, if they intend to keep oil prices near current levels, crude could weaken even further as some other producers increase supplies in an effort to reduce revenue losses.  However, that would not only halt most new shale drilling within a few months, but also knock out some other high-cost oil producers.  Shell could ride that out, hopefully without cutting the dividend, and benefit when oil prices moved back up towards the $80 to possibly $100 range.  Meanwhile, there is currently a spread of at least $60 in the high / low forecasts for crude. 

A well capitalised, managed, and diversified major energy producer should be capable of doing quite well in this rapidly changing environment.  However, there will also be a number of dinosaurs in this industry, both large and small, which may not survive.  I maintain that crude oil prices will move erratically lower in real terms over the longer term.