Cheap oil makes prized dividends of 7 oil majors unsustainable - Business Insider

The coronavirus pandemic is slamming the oil and gas industry after causing the price of oil to collapse. Major oil companies are scrambling to cut costs to respond.Current dividend payouts from seven majors are not sustainable, a top analyst at IHS Markit told Business Insider. “The risk is increasing that dividends will be cut if prices stay below $40,” he said. Visit Business Insider's homepage for more stories.

From ExxonMobil to Shell, the world's supermajors are no strangers to an oil price collapse.They've dealt with them many times before and survived. And during the last downturn, as recent as 2016, all but one major company — the Italian giant, Eni — was able to preserve their prized dividend payouts. But this oil price collapse is different. It wasn't just ignited by a price war, as in years past, but by an epic cratering of demand. That means that both oil production and downstream activity like refining are taking a hit. What's more, oil majors are far more leveraged this time around, says Lysle Brinker, an executive director of equity research and analysis at the research firm IHS Markit.

In other words, they're carrying more debt. Brinker tracks seven top oil majors: Chevron, ExxonMobil, Shell, BP, Total, Eni, and Equinor. And he says that, on average, their ratio of debt to capitalization is about 5 percentage points higher now, at about 30%, relative to the last downturn. “Based on our projections for the next couple of years, they're going to go up even further to say 33% or 34% depending on what happens with the low price,” he told Business Insider.

The Italian energy giant Eni cut its dividends during the last price downturn.

Alessandro Bianchi/Reuters

Higher debt puts dividends at riskThat spells bad news for these companies' dividends, he said. “Dividends are at much greater risk, we believe, this cycle, compared to last cycle, because they're starting from a more-leveraged balance sheet standpoint,” he said. “We don't think these dividend rates are sustainable, certainly if the oil price stays below $40 or even $50 for the next few years.”

Dividends for these seven companies are going to take up as much as 60% of their cash flow this year, according to Brinker's forecast. “That, I think, is the highest it's ever been,” he said. “So even with some recovery in oil prices, the dividend is still taking up a huge chunk of the cash flow.” In the last downturn, when the majors were short on cash, some of them turned to scrip dividend programs, whereby they offer stockholders company shares instead of cash. But Brinker says the group of companies isn't as well-positioned to offer that program this year because the “stocks have been hammered so hard” and have, more generally, fallen out of investor favor. “We don't believe that the scrip dividend programs are going to be used as much because it's just silly to be issuing new equity with the dividend yield at that high a level,” he said.

BP is one of the more-leveraged companies among the seven majors, Brinker says

Reuters

Oil majors go to extreme lengths to protect their dividends So which companies are most likely to cut their dividends？

Those that are most leveraged, Brinker said. And right now, that's Eni and the supermajor BP, he said. But Brinker notes that the majors are “expected to defend their generous dividend payouts for as long as possible, as this is key to satisfying investor expectations of returning funds to shareholders.” That's why these companies are taking some extreme cost-cutting actions, such as slashing their capital expenditure by an average of about 23%, per Brinker's calculation, and laying off staff. Eni, for example, cut its 2020 capex by 25%, according to a public statement in which its CEO Claudio Descalzi said “we are taking these actions in order to defend our robust balance sheet and the dividend while maintaining the highest standards of safety at work.”BP also cut its capex forecast by 25% and said that it remains “committed to growing sustainable free cash flow and distributions to our shareholders over the long term,” according to a public statement.

In an even more extreme scenario, Brinker says it's possible that there'd also be some mega-mergers on the horizon. “There are too many companies chasing too few opportunities,” he said. It all depends on where the price of oil falls. Over the weekend, OPEC Plus, a coalition of oil-producing countries, finalized a historic deal to cut production by 9.7 million barrels per day (bpd).Other countries including the US and Canada will contribute to additional cuts amounting to 5 million bpd or more, driven largely by market forces.

But while these cuts are deep and unprecedented, they'll do little to boost the price of oil, according to top industry analysts, because the collapse in demand is so severe.Once demand returns, higher prices will follow.