The big one-day drop in oil prices on May 18 should definitely have energy investors scared but not panicking. The sector already had a tremendous run, so any pullback is expected. Last week, oil prices fell on reports Saudi Arabia and Russia would form a deal that increase oil production by around one million bbl/day. If it’s true, should it matter? In the short-term, it will not.
OPEC is holding up to oil output cuts. If Saudi Arabia and Russia raise supply, oil prices will fall but the demand will make up for the higher output. That puts vertically integrated firms on the watch list, including BP (NYSE: BP) (fw P/E 13.4x), Royal Dutch Shell (NYSE: RDS.A), with a fwd P/E of 11.3 times, and due to valuation, and Chevron (NYSE: CVX), whose stock yields around 3.7%.
Any agreements that raise supply will likely put pressure on oil prices but oil firms are already very lean. BP is especially very lean, operating at higher efficiencies because it sold off its non-core assets years ago. Debt/equity is slightly higher than its peers but the discount in its stock makes up for the higher leverage risks.
Disclosure: Author owns shares in BP plc.
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