In this article Ill explain which company I believe is the better buy at the moment, and ask whether BG Group (LSE: BG) could offer even better value.
BP vs Shell
So far this year, BP shares have risen by 6%, outperforming those of Shell, which have fallen by 15%.
However, if you stretch the timeline out to ten years, the full scale of the damage caused to BP shareholders wealth by the Gulf of Mexico disaster becomes clear. BP shares are 25% lower than they were in June 2005, while those of Shell are 6% higher.
Is BP cheaper than Shell?
Shell shares currently trade on a 2016 forecast P/E of just 10.5, compared to 13.2 for BP.
Similarly, Shell offers a prospective yield of 6.6%, compared to around 5.9% for BP. Based on forecast P/E and dividend yields, Shell is cheaper and could be a better buy.
However, earnings are not the only way to value an oil company. A measure widely used by professional investors is the ratio of enterprise value to reserves.
The purpose of this is to show how much you would pay for each barrel of a firms proven and probable (2P) oil and gas reserves if you bought the company.
There are some big differences between Shell and BP:
EV/boe* 2P reserves
(*barrels of oil equivalent)
At just $8.60 per barrel, BPs reserves appear to be some of the cheapest in the industry, and are half the cost of Shells. How can this be?
The answer is Russia. BPs 20% stake in Russias largest oil producer, Rosneft, allows it to add a share of Rosnefts huge reserves to its portfolio. According to BPs 2014 annual report, 38% of its total reserves come from its stake in Rosneft.
If we exclude BPs Russian reserves from its portfolio, then BPs EV/boe ratio rises to a more normal $13.80 per barrel. Still cheaper than Shell, but only just.
This suggests that BP is only really cheap if you are confident that its stake in Rosneft will be a long-term success. I suspect it will. Big oil plans for several decades ahead, and the current sanctions are a relatively short-term problem for these companies.
The BG question
Shells management knows it needs to add more reserves to its portfolio. Thats why the firm launched a 47bn takeover bid for BG Group earlier this year.
BG has proven and probable reserves of 6,525 million barrels of oil equivalent. Acquiring these will increase Shells reserves by around 50% in one fell swoop, without the need for years of costly exploration and appraisal drilling.
Shells offer for BG was approved by the US Federal Trade Commission last week, giving the company the first of several approvals needed for the takeover to go ahead.
Im confident the deal will go through, but the market is still pricing BG shares at an 11% discount to the value of Shells offer.
As Shells offer is a mixture of cash and Shell shares, this means that you can buy new Shell shares at an 11% discount by buying BG shares and waiting for the deal to complete.
Of course, this kind of arbitrage isnt without risk.
Personally, I’d prefer to focus on the fact that the majority of investment t returns come from dividends, and focus on whether BP or Shell offers the safest long-term income.
One way of doing this is by using the five golden dividend investing rules in “How To Create Dividends For Life“.
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Roland Head owns shares of Royal Dutch Shell. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.