When Rystad Energy analysts last November told Bloomberg that Big Oil investors were in for a windfall of dividends and share buybacks as the companies shifted into renewables, they couldn’t have known that just four moths later oil prices would dive to lows unseen for years and that the prospects of an improvement will be bleak.
But this is where we are now: with Saudi Arabia effectively declaring a price war on Russia—and U.S. shale by extension—Brent crude is trading at below $40 and WTI is getting increasingly closer to $30. Will shareholders say, “That’s all right, you can suspend dividends?” Not a chance.
The latest oil price crash, just four years after the last one that mobilized OPEC into acting together with other producers, has starkly highlighted an already existing problem. Big Oil does not have the cash to cover all its ambitious dividend and stock buyback plans. It couldn’t cover them when Brent was trading at $60. Now, with the international benchmark close to half that, the problem just got more acute.
The Institute for Energy Economics and Financial Analysis this January published a paper revealing a solid gap between supermajors’ dividend payouts and their free cash flows: the money that pays the bills as Bloomberg once aptly described it. Shell, BP, Exxon, Chevron, and Total collectively paid $545.9 billion in dividends between 2010 and the third quarter of 2019, the paper’s authors said, while free cash flow during the same period totaled $328.7 billion. The shortfall of $207.2 billion was covered by asset sales and new debt.
One doesn’t need a degree in economics or finance to understand that this situation is unsustainable. One needs even less in the way of education to grasp exactly how much worse this already bad situation is going to become now that prices have tanked. What’s next? Spending cuts, including from dividends.
“Buybacks and dividend growth are now almost certainly off the table, and questions on who will need to cut the dividend first will be topical,” Jefferies analyst Jason Gammel wrote in a note cited by Reuters. Goldman Sachs chimed in, expecting a new round of belt-tightening among Big Oil majors, with Chevron likely to wind down its share buyback program and Exxon cut its $33-billion spending plan for this year.
The price collapse couldn’t have come at a worse time – just when Big Oil was beginning to regain the trust of investors, mostly by promises of higher cash returns in the form of dividends and share buybacks. Last year, Shell, Total and Conoco announced plans to boost dividends, with Shell promising shareholder returns of at least $125 billion between 2021 and 2025, Total promising annual dividend growth of 5-6 percent from the 3-percent annual growth rate at the time, and Conoco bumping up its quarterly dividend by as much as 38 percent.
Now these plans will need to be revised and this won’t make investors happy. However, there is precious little else Big Oil can do in the circumstances. The supermajors could probably keep up the dividend payments for a while, but raising them would be a challenge as even the most confident investment bank analysts would likely be wary of speculating when this particular crisis will end, now that it’s not just the COVID-19 epidemic pressuring demand but also Saudi Arabia turning the taps on, promising a deeper glut.
Barron’s wrote at the end of February that Chevron and Conoco could cover their 2020 dividends at Brent prices of $57 and $55, respectively, Exxon’s situation was much worse: the supermajor, according to JP Morgan analyst Phil Gresh, would need oil at $87 to cover its dividend payout for 2020 from earnings. The Europeans—Shell and BP—are faring better in terms of breakeven prices, with $40 per barrel for BP and $51 per barrel for Shell, according to Bernstein analyst Oswald Clint.
With Brent much lower than even BP’s breakeven price, the supermajors will clearly not be covering their dividend payouts from earnings. Those will take a hit from the COVID-19 epidemic and the price war. This is the sort of uncertainty investors dislike intensely, especially after the 2014 crisis. With energy stocks consistently underperforming the index in the years following the crisis, despite improving earnings, an outflow of investors is a distinct possibility if the crisis continues.
Time is the key element here. Investment banks have already started revising their oil price and oil stock price forecasts for this year, adding to the pressure on benchmarks but also adding to negative sentiment among investors. The longer this state of affairs continues, the worse the sentiment will likely become, and Big Oil will begin losing investor trust pretty quickly. What makes the situation even more challenging is that supermajors will have to be frugal, and this might stop them from building trust with investments in renewable projects: the sustainable path investors like to see Big Oil take.