One of those is Royal Dutch Shell (RDSB). Unless you have been living under a rock, you’ve probably seen headlines that “oil trades negative for the first time in its history”. It was actually the May futures contracts that expired early this week on Tuesday that plunged below zero and not the spot price of oil. The negative price was driven by several factors, as we explore in this week’s cover feature. But the reasons for the historic fall are really quite simple:
• Demand for oil is dramatically down, which means inventories are expanding.
• Storage space is drying up, and the price of storage is rising.
• Speculative traders were eager to offload their contracts in order to avoid taking delivery of the oil and the costs incurred in storing it.
It’s important to remember that an instrument and its underlying asset are separate from each other. The asset, in this case the oil, is tangible and has real costs, whereas the instrument attached (a futures contract) is just a price for a fixed point in time in the future made up by buyers and sellers. Traders tend to care more about the price of the asset rather than what the asset is, and this is the key difference between trading and investing.
In extraordinary situations prices can be pushed out of sync with the intrinsic value of the asset. This divergence and volatility can cause distressed prices, which are opportunities for traders. While oil futures certainly were trading negative, reporting that oil prices were negative is misleading – one should always check the facts before believing the media.
However, the price of oil has real consequences for many of London’s oil exploration & production companies. Royal Dutch Shell in particular, has seen the kind of extreme price volatility one would more usually expect from a speculative Aim stock bouncing around on hype.
Let’s look at Chart 1, which is the price action of Shell during the 2015 commodities crisis. The price hit lows around 1,260p before beginning a rebound.
This pattern is a cup and handle pattern – a set-up I will be looking for in the next bull market when it comes. The cup part of the chart shows a bottom, and the handle is formed when the price fails to break the high of the cup and then falls, only to see buyers stepping in to support the price. We can see that in July 2016 the price broke free from the resistance and rose to 2,150p and consolidated, before continuing the trend.
Back then, Shell’s depressed share price meant a dividend yield of over 10 per cent. As regular readers and investors will know, a double-digit dividend yield is a sign that the market views the dividend as being unsustainable. But Shell has never cut its dividend since 1945 – hence the old stock market adage ‘Never sell Shell’.
The Shell of 2015 is very different to the Shell of today, though. Recently, we’ve had Greta Thunberg and Flygskam – or ‘flight shaming’ in English – and of course Covid-19. Books will be written about Tuesday’s oil price futures crash, as entire firms will have been wiped out as others have made fortunes. Many oil companies use hedges, however, but I think there is a valid reason for some concern over whether or not those hedges are honoured. It’s not unfair to assume some hedge providers may well go bust.
The dividend yield of Shell is again over10 per cent, and income investors must be both tempted and wary. They know that chief executive Ben van Beurden has been here before, that the company has taken on additional debt in order to avoid slashing the dividend, and that Mr van Beurden will want to avoid going down in history as the first boss since WWII to cut the company’s dividend. It must be assumed that all options will be explored before it comes to this.
However, this is a topic for income investors, not traders like myself. Looking at Chart 2, the price action of Shell leaves a lot to be desired. We can see that since August last year, the price tested the 200-day exponential moving average twice, and so that will be key resistance in the future. The current price is nearly 30 per cent below this level, and with oil continuing to slide this will only increase pressure on the company.
The price finally made a snapback rally a few weeks ago, but is now sliding lower. I can’t see any justification for being long here unless you are either a daring income investor or a gambler. It’s possible and even likely that Shell may trade at a higher price in future, but trading is about odds and risk management. At the moment, the trend is down and the bottom is not yet confirmed.
Many traders are going to be eyeballing the recent low of 900p where the stock closed at 917p, and gapped down to 890p the next day where it rallied hard. Clearly, sizeable demand was coming in for the stock sub-900p and this will be a big test of the stock’s future direction.
My view is that when the stock was falling we had no reference point as to how far the stock could go, but now we can see a clear support point to trade from. Taking a long position below 900p gives us a great entry and opportunity to get out for a small loss if support does end up failing. Given that Shell has fallen so far already I’d be reluctant to short support, but I’m willing to ignore that opinion as the lowest price any stock can go to is 0p – any stock can fall a lot further. Stranger things have happened. Who would have believed last week that you could get paid for taking delivery of oil? The market will always continue to surprise.
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