Oil company dividends: flare-up ahead

August 21, 2016

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Companies pay dividends to reward their shareholders, and to signal confidence. Management is pushing out its chest: we will be here for years to come, and we have the money to prove it. That confidence has to be backed by growing cash flows. But in the commodities sector, now is not the time for such bravado. Big mining companies have already made the . Major oil companies — , , and — should follow suit.

In theory, better earnings — and therefore dividend growth — do not necessarily require rising revenues. Get costs down, and perhaps do an acquisition or two, and over time profits should expand enough to give your shareholders something for hanging around. But the reality of commodity industries is that the advantages of lower costs get competed away over time. Consider that the price of a basket of the major commodities has fallen over 1 per cent annually in real terms since 1934, according to research from Robeco, an asset manager.

Certainly oil prices have struggled in recent years. Adjusted for inflation, Brent crude prices at $22 per barrel are not much above their average since 1983. As cash flow has withered the oil companies have done what they can to cut costs and capital spending. However, some of the biggest companies — such as BP and Shell — still need to sell off parts of their businesses, and perhaps , to pay dividends.

So the big producers cannot maintain their dividends if oil prices do not go up. In order to pay a dividend, the largest oil producers need oil at $63 just to cover dividends and investment with cash flow, according to consultants Wood Mackenzie. Even if that break-even price comes down in years to come, the threat to dividends is clear. Brent is currently struggling to stay above $50.

Confidence is fine. . Four of the oil majors so far refuse to cut their dividends. They will need to do so.

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Category: Oil & Gas