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As Shell Raises Dividend, Future Gets Hazy

THE WALL STREET JOURNAL

MARCH 18, 2009

LONDON — Royal Dutch Shell said it would pay $10 billion in dividends this year, up 5% from 2008, establishing Big Oil as a notable exception to the wave of blue-chip companies that are cutting their payouts to shareholders.

But some investors are questioning whether the supermajors can sustain their generous dividends amid a global recession that has depressed energy demand and lowered crude prices.

[Shell's Reserves Unchanged in 2008]Reuters

There are concerns that the oil majors are subjecting themselves to financial strain by maintaining high payouts, especially as some companies will have to borrow to pay dividends.

Even as it raises its dividend, Shell is paring the number of projects it undertakes to cut costs. That has made it harder for Shell to promise long-term output growth — a sensitive issue for a company that has seen its production of oil and gas decline for the last several years.

Last year, Shell announced long-term growth potential of 2% to 3% a year through the next decade. But Tuesday, the Anglo-Dutch company would commit to that growth only for the next three years, declining to forecast beyond then. Shell also said output would be flat or slightly lower this year.

“We have to plan on the basis that the economic downturn could last for more than a year,” Chief Executive Jeroen van der Veer said as he presented the company’s latest strategy update to reporters. But he said Shell’s balance sheet was strong enough to support investment and dividends throughout the slowdown. Shell said in January it would increase its dividend to 42 cents a share this quarter from 40 cents, but didn’t commit to its payout for the year.

Shell’s dividend illustrates how major Western oil companies are bucking a trend elsewhere in the corporate landscape, where rewarding shareholders is taking a back seat to shoring up balance sheets and conserving cash. Most of the other oil majors are holding their dividends steady.

[oil companies and shareholder returns]

Banks were the first to cut their dividends. Their ranks were joined by others including Dow Chemical Co. and General Electric Co., which recently cut its payout for the first time in 71 years. Goldman Sachs Group Inc. forecasts a 22% decline in dividends among companies in the Standard & Poor’s 500-stock index this year, the steepest drop since 1938.

There are concerns that the oil majors are subjecting themselves to financial strain by maintaining high payouts, especially as some companies will have to borrow to pay dividends. That strain will only increase if the oil price stays stuck at its current level of around $49 a barrel this year and into 2010.

“There’s a question mark over them if the oil price continues to decline,” said Colin Morton, investment director at Rensburg Fund Managers. “They’ll have to decide whether they’re better off maintaining the dividend or reducing it and using the money for other things, such as increased capital spending.” The issue is critical for investors, many of whom hold shares in the supermajors because of the reliable income streams they provide.

Shell, which hasn’t cut its payout since World War II, said it will increase debt to cover its dividend, if necessary. The company said it expects its gearing, the ratio of net debt to net debt-plus-equity, will increase to the low 20% range this year from 6%. Given Shell’s size, that is “very comfortable for us,” said Chief Financial Officer Peter Voser, who has been selected to succeed Mr. van der Veer as CEO when he retires later this year.

BP PLC has made similar assurances. It has said it needs oil to fetch $60 a barrel for the company’s cash flow to cover capital spending and dividend payments this year. But the company said it can easily raise debt to cover any shortfall. Its current gearing of 21% is at the low end of the 20%-to-30% range it considers prudent.

However, BP’s gearing already is the second-highest among the majors, after ConocoPhillips, so it has less room for maneuver than Shell does. Crude closed Tuesday at $49.16 a barrel. (Please see commodities coverage on page C14.)

It’s not only BP that is vulnerable. Standard & Poor’s has warned that all the European supermajors — BP, Shell, Total SA and ENI SpA — could face ratings downgrades this year or next if oil’s price doesn’t recover.

At issue is a vast flow of money. Last year, the six supermajors returned nearly $100 billion to shareholders. And as the once-dependable banks cut payouts, Big Oil’s contribution has grown in importance. BP and Shell account for almost a fifth of the dividends paid by U.K. companies.

The outlook for the majors is darkening, however. The price of oil has fallen by $100 a barrel since its highs reached last July. It is now at levels last seen in 2004, yet industry costs have doubled since then. And unlike in previous periods of low oil prices, the majors have committed themselves to keep investing heavily through the downturn. Shell’s roughly $32 billion capital-expenditure program for this year is the largest in its history.

U.S. rivals like Exxon Mobil Corp and Chevron Corp have more wiggle room. A higher percentage of their returns to shareholders is in the form of stock buybacks, which are easier to reduce without fear of a backlash from investors who count on dividends.

One thing in the oil companies’ favor: The world is in its worst recession for decades, meaning that oil-industry costs are bound to come down this year. BP expects operating costs to fall by $2 billion this year.

But Shell’s Mr. van der Veer says that with oil and gas projects now much more complex and expensive than they were five years ago, he doesn’t expect costs to return to pre-2004 levels.

Write to Guy Chazan at [email protected]

Printed in The Wall Street Journal, page B1

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