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Big Oil’s Costly Love Affair With the British Pensioner

Crude’s fall raises new questions about huge payouts.

By Chris Bryant: 29 June 2017

Europe’s big oil companies have spent the past couple of years slashing costs because lower crude prices mean there’s less cash to balance the books. Despite those strains, most have left shareholder payouts untouched.

Now, with oil prices falling back into a bear market, the dividend yields of several European integrated oil stocks have widened again. Levels like these usually indicate a dividend cut is on the cards: 

That’s still probably not the case though. British income investors (and many pensioners) depend on Royal Dutch Shell Plc and BP Plc, which together account for more than 10 percent of FTSE 100 dividends, notes Macquarie. Shell’s alone cost an eye-watering $15 billion. Their boards’ credibility would suffer if they suddenly reversed course. Fortunately for management, there is a get-around but it looks like an expensive fudge.

BP, Shell and France’s Total SA are among several big oil and gas companies who’ve been covering part of their dividend promises in shares instead of cash. 1 Relying on so-called “scrip dividends” puts them in dubious company. Europe’s banks have been doing similar. Finance and commodity companies account for two-thirds of European scrip payments over the past decade, according to IHS Markit.

Shell, BP and Total conserved almost $12 billion in cash last year via scrip payments, according to my calculations, or more than one-third of the total dividend cost. That was a godsend because the companies carry lots of debtWith crude rising to an average of $54 in the first quarter, things had started to look better. Shell’s cash from operations covered its capex and dividend costs, though BP didn’t achieve cash neutrality even with the scrip in place.

In fairness, if oil prices were to recover quickly a scrip dividend might be pretty harmless. That seems to have been the industry expectation. Shell’s 2016 annual report discusses how oil markets could tighten in 2017 and that by 2020 Brent could be as high as $80. 2  Similarly, Total promised to end its discounted scrip when oil prices reached $60.

But with copious U.S. tight-oil production threatening to overwhelm OPEC efforts to bring crude markets back in balance, even $60 oil is looking a stretch. It’s conceivable companies will have to keep the scrip for longer.

That’s troubling because issuing new shares dilutes shareholders. Paying in scrip could also push up the cost of restoring a full cash dividend because you end up with more shares outstanding. 3 Moreover, while the scrip’s in place, investors will keep fretting about a dividend cut, which could limit upside for the stock. A Deutsche Bank study found 40 percent of companies that offered scrip in 2012 cut their dividend during the next three years.

After the latest fall in oil prices, Iain Reid at Macquarie thinks “further, painful cost reductions” might be on the cards. The trouble is, at some point lower spending starts to endanger growth. Citi analysts have questioned the “rationale behind companies with more stretched balance sheets and high dividend payouts defending equity at the expense of balance sheet repair and future investment.”

There is an alternative that might be worth considering, even if it humiliates the bosses. Austria’s OMV AG cut its dividend for the 2015 fiscal year and the shares have outperformed. True, investors seem to like its low cash break-even point, low gearing and exposure to natural gas. Even so, the stock’s rise suggests a dividend cut needn’t be so terrible.

If oil companies can afford to pay their dividend promises in cash, so much the better. If they can’t, there’s no shame in not promising quite so much in the first place.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. This isn’t such an issue in the U.S. because companies there make more use of share buybacks.
  2. To be fair, Shell also noted a risk that oil prices could fall back to 2016 levels if OPEC abandoned production cut pledges or U.S. shale producers were able to supply lots of cheaper oil.
  3. Companies typically buy back shares to reduce the share count again but that could be expensive if stocks prices have followed oil prices higher.

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