Big Oil should cut dividends amid Covid-19 price slump investors
he world’s biggest oil and gas groups should break an industry taboo and consider cutting dividends, rather than taking on any more debt to maintain payouts as they weather fallout from the coronavirus pandemic, investors say.
The top five oil groups avoided reducing dividends for years to keep investors sweet and added a combined $25bn to debt in 2019 to maintain capital spending, while giving billions back to shareholders.
The strategy was designed to maintain the appeal of oil shares as investors came under more pressure from climate activists to ditch the shares and help the world move faster towards carbon emissions targets.
Now this strategy is at risk. Oil prices have slumped 60% since January to below $30 a barrel as demand collapsed because of the Covid-19 pandemic and as a battle for customers between Saudi Arabia and Russia threatened to flood the market with crude.
“Long term, it is appropriate to cut the dividend. We are not in favour of raising debt to support the dividend,” said Jeffrey Germain, a director at Brandes Investment Partners, whose portfolio includes several European oil companies.
TThe combined debt of Chevron, Total, BP, ExxonMobil and Royal Dutch Shell stood at $231bn in 2019, just shy of the $235bn hit in 2016 when oil prices also tumbled below $30 a barrel. Only Chevron reduced debt last year.
The latest plunge in oil prices sent energy companies reeling, just as they were recovering from the previous crash, when crude plunged from $115 a barrel in 2014 to $27 in 2016.
Companies from Exxon to Shell have announced plans to cut spending and suspend share buyback programmes to balance their books and prevent already elevated debt levels from ballooning.
None announced any plans to cut dividends so far.
Shell, which paid $15bn in dividends last year, prides itself for having never cut its dividend since the 1940s. This week it announced plans to slash capital spending by $5bn.
But with the highest debt pile among rivals of $8bn at the end of 2019 and an elevated debt-tocapital ratio, known as gearing, some investors say Shell might have to halve its dividend to balance its books.
“The measures taken by Shell seem to be sufficient but, over time, if Shell (for instance) does not spend enough capital expenditure then production will start to fall and the underlying cash flow will not be sufficient to sustain the dividend long term,” said Jonathan Waghorn, co-manager of the Guinness Global Energy Fund.
A Shell spokesperson declined to comment.
Even if oil prices recovered to the low $40s a barrel, oil majors’ debt would rise to levels that were too high by 2021, said Morgan Stanley analyst Martijn Rats. “Much remains uncertain, but if commodity markets evolve as expected, we think European majors will start to reduce dividends in the second half of 2020.”
BP, which last cut its dividend in the wake of the 2010 Deepwater Horizon rig explosion, has yet to announce a detailed plan to weather the crisis. BP declined to comment.
“Given all the negatives, I see no long-term downside to cutting the dividend temporarily and, once circumstances change, raising it accordingly,” said Darren Sissons, portfolio manager at Campbell, Lee & Ross.
The dividend yield — the ratio of the dividend to the share price — on oil group stocks leapt in recent weeks after the collapse in crude prices, hitting levels not seen in decades.
A high dividend yield can imply investors are assigning a higher degree of risk to a company’s dividend but the big oil companies would not want to reduce payouts, said Alasdair McKinnon, portfolio manager at The Scottish Investment Trust.
“Oil majors will be extremely reluctant to cut dividends. They have historically defended them through some very tricky periods.”