Long-Term Investors Shouldn’t Count On Big-Oil Dividends

An oil major’s dividend is its solemn pledge that it will deliver no matter the vagaries of the market. But no one planned on those vagaries including negative oil prices. So can Big Oil maintain its dividends? Should it?

As so often in this business, oilfield services provide early warning. Announcing quarterly earnings, Schlumberger Ltd. slashed its dividend by 75%, its first cut in at least four decades or so. The stock actually jumped 9% that day. Meanwhile, Halliburton Co. held off cutting but also made it clear it would have no qualms doing so if necessary. Its stock didn’t jump, but did close in the green despite oil closing with a minus sign in front of it that day.

Aggregate indebtedness at the big five Western oil majors — BP Plc, Chevron Corp., Exxon Mobil Corp., Royal Dutch Shell Plc and Total SA — has also jumped since 2014. And as a group, they only just covered capital expenditure and dividends from operating cash flow in 2019, when Brent crude oil averaged $64 a barrel. So while they aren’t quite in the same boat as the services firms, they’re getting uncomfortable.

There is a strong case to be made that having a progressive dividend in such an inherently volatile business as oil is asking for trouble. Big Mining acknowledged as much back in 2016, when BHP Billiton Plc, for example, switched away from progressive dividends to tying its payouts to a percentage of (fluctuating) profits.

A dividend that erodes the balance sheet, thereby raising the risk premium, stops being a down-payment on value and ultimately becomes a drag on it. Put another way, above a certain level, dividend yields indicate the market isn’t paying up for promises of more — so maybe just stop promising.

Oil majors have ridden out prior downturns, usually leaving dividends untouched, through a mixture of borrowing, selling assets and cutting costs. But the seams have split at various points. BP temporarily suspended dividends after the Deepwater Horizon disaster (a decade ago this month), and both Royal Dutch Shell and Total instituted scrip dividend programs — whereby investors take new stock rather than cash — in the previous oil crash. Shell’s annual dividend per share, meanwhile, has been flat since 2014, the last year of triple-digit oil prices.

Moreover, the implacable issue of climate change stokes expectations of peak demand, making promises of ever-rising dividends look even more incongruous. So why not use the shock value of negative oil prices to reset dividend policy?

Psychology is a big factor. The dividend is a fixed point to cling to in a changing world. It’s also the last bond of trust between the sector and investors. Big Oil’s capex boom saw capital employed for the big five jumping by half even as earnings dropped by almost half over the past decade, trashing returns.