The oil major's third-quarter reporting season to get underway soon and, after a recent slump in commodity prices, investors will be more eager than ever to see how these blue-chip favourites are coping.

Although these quarterly numbers cover the period largely before the recent downturn in prices - Brent Crude is down 7% year-on-year - Deutsche Bank reckons that previous dispersion in the major's earnings will continue into this season. A 19% fall in exploration and production (E&P) earnings is expected to drive down weighted average year-on-year earnings by 3%.

"In recent months our stance on the sector has been that as a wave of new projects commenced production, operating cash flows should be expected to advance," say Deutsche analysts. "Combined with the signs that the capex cycle was peaking and that companies were showing increased capital constraint this, we believed, would drive a material improvement in free cash flow and with it greater investment confidence in the sustainability of dividends - a positive for share prices."

They expect forward capital expenditure objectives to be given with fourth-quarter results, but next week they urge investors to keep their eye out for the influence on cash flow from launching projects and costs restraints.

While upstream operations face challenges, downstream exposure (refining and marketing) is expected to offset any poor performance, with earnings before interest and tax rising by 21% year-on-year.

"For once exposure to European refining markets thus looks set to prove a, we expect temporary, positive with third-quarter 2014 expectations holding scope for surprise to the upside," says Deutsche.

Enter gas, stage left

But with all the noise about falling oil prices, it's easy to overlook the other string the international oil companies (IOCs) have to their bow.

"Of particular interest is the rally in the European natural gas prices, where UK NBP prices have risen nearly 27% since July this year," writes Barclays.

Despite this rally, prices are still around 23% lower than this time last year, which is largely down to companies stockpiling reserves to cover their backs if Russia decides to play hard ball. Currently stocks are 93.7% full, according to data from the analysts.

"If the weather gets colder and demand picks up, we expect natural gas prices to continue to rebound. While some of the production in UK and Europe is sold on a contract rather than a spot basis we believe stronger gas prices will go part of the way to offset the impact of the near-term weakness seen in oil prices."

Opportunity for deals on AIM

There also seems to be a positive correlation between the price of oil and the cost of drilling, Will Holland, chief financial officer at Fastnet Oil & Gas (FAST) told Interactive Investor. Does this mean the recent fall provides a good opportunity for AIM-listed explorers? Holland is not so sure.

"At the moment, AIM-listed explorers are suffering. The exploration market tends to be quite risk averse as there hasn't been much success. However, a couple of companies have recently made some pretty decent discoveries, so hopefully we are turning the corner.

"There are so many companies sitting on AIM at the moment that have got very, very weak balance sheet but have reasonable assets. So the opportunity to pick up these assets or do corporate deals is definitely there. There isn't the appetite within the investment community at the moment to support these companies because they haven't delivered. So if you are sitting here with a strong balance sheet, it puts you in a good position to do some very good deals," he adds.

The European Integrated Oils sector is trading on a price/earnings multiple of 11 times, according to Deutsche Bank, and the investment community has not completely turned its back on oil. Investors are piling into respective tracker funds at the fastest rate for two years, according to Bloomberg data, suggesting prices may rebound. Interactive Investor takes a look at what investors can expect from Shell and BP next week.

Royal Dutch Shell (2,299p)

Shell (RDSB) impressed with its second-quarter results, doubling net profit to $5.1 billion (£3 billion). Prior to the period, the group had three volatile quarters, so the update was more than welcomed - save the dividend.

"Its downstream cost reduction, at a time of improved refining margins, should also add leverage with marketing expected to benefit from the 'parachute' effect of falling input costs," said Deutsche Bank.

With production set to fall by 5% to 2.9 million barrels of oil per day on the quarter, the analysts expect upstream earnings to fall 18% to $3.9 billion, driving down total operating income by 13% to $5.3 billion. Production will be flat on the year. Slightly offsetting this drop will be improvements in downstream earnings, jumping to $1.4 billion. Compared to the same period last year, total earnings will be up 21%, upstream up 12% and downstream up 59%, just highlighting improvements despite recent turbulance.

The analysts warn that uncertainty surrounds forward guidance due to market volatility, with downgrades on the cards. But, for now, they have a 'buy' recommendation on the stock with a 2,850p target price.

They said: "Our 'buy' stance, which assumes $103/bbl oil in 2105, is predicated on the robustness of Shell's cash flows and potential for greater return on capital employed and cost focus to engender underlying progress," however they warn that project delays could hit the company hard.

With forward EPS guidance of 3.86 cents, Shell is trading on nearly 10 times earnings, at a discount to the sector.

BP (439p)

BP (BP.) hasn't had as much to prove compared to Shell over the recent year. It's been performing well and Deutsche Bank expects this to continue thanks to upstream volume improvements and downstream ramp-up. But, with a hefty amount of its revenue coming from Rosneft, the weak rouble and impact of Russian sanctions are set to leave a nasty gap. Deutsche Bank reckons profit from Rosneft could fall from $1 billion in the second quarter to just $200,000.

But a respite could appear in downstream operations, with a rise in performance compared to the last quarter's fall, due to improvement in margin capture in both European refining and marketing, and a marked increase in output from its US Whitling refinery.

Production is expected to fall 3% on the year including Rosneft, and 6% excluding the company. Upstream earnings excluding Rosneft is set to fall by nearly a third to $3.9 billion, with Rosneft's earnings plummeting 83% to $179 million. Downstream income is set to rocket by 87% on the quarter however, nearly doubling last year's figure, to $1.4 billion.

Also vulnerable to downward revision, BP currently trades on 9 times forward earnings, a discount to both the sector and Shell. The analysts put a 'hold' recommendation on the stock with a 550p target price.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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