Shell(LSE: RDSB) has risen by 43% in 2016. Therefore, many investors may feel that it's now due a fall in price as profit taking and a higher valuation cause sentiment to weaken. However, here are three reasons why Shell should continue to rise and could reach £30 per share over the medium term.
The price of oil has risen from January lows of less than $30 per barrel to over $50 per barrel. That's despite there continuing to be a glut in supply which is showing little sign of reducing in the short run. However, over the medium term there's a good chance that the price of oil will continue to rise because of a planned cut in production by OPEC. At its most recent meeting it decided to reduce production to less than 33m bopd, which could help to alleviate the supply/demand imbalance that exists today.
Alongside this is increasing demand from emerging economies for oil. And while renewables are becoming more important in the developed world, the reality is that oil is set to be a key part of the energy mix over the coming years. Therefore, it would be unsurprising if its price moved further upwards. This would boost Shell's financial performance and potentially its share price.
Shell's deal to buy BG Group could prove to be a positive catalyst on its financial performance and share price. It increases Shell's exposure to LNG assets and this could be a growth area in the long run. Demand for LNG is on the rise in China as it seeks to improve its environmental sustainability. As such, it's likely to replace coal-fired power stations with cleaner burning LNG.
The acquisition of BG also provides the potential for synergies. In fact, Shell recently announced that synergies from the deal are likely to be higher than previously expected. This could boost Shell's cash flow, with the company now expected to produce free cash flow of over $20bn per annum by 2020. This would allow it to invest in more acquisitions and to also develop its current asset base yet further.
Shell currently yields 6.9%. This makes it hugely appealing to income-seeking investors at a time when the Bank of England has adopted a more dovish monetary policy stance. As such, demand for Shell's shares could increase as investors seek out higher yielding shares. In fact, if Shell was to trade at £30 per share, it would still yield around 5.1%. This is 150 basis points higher than the FTSE 100's yield.
While dividend coverage may be lacking right now, Shell's synergies from BG and the subsequent rise in free cash flow should mean that dividend growth is brisk over the medium term. Therefore, a share price of £30 doesn't seem to be difficult to justify.
Peter Stephens owns shares of Royal Dutch Shell. The Motley Fool UK has recommended Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.