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Oil slump highlights pressure on dividend payouts

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Screen Shot 2015-08-04 at 22.49.59Extracts from an article by Garry White: 22 Aug 2015

Some in the City are concerned that distributions to shareholders at some major dividend payers are too high. This is particularly true for the oil sector.

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Based on current forecasts, the prospective yield in 2016 for BP is about 6.9pc and for Shell it stands at 6.7pc. These unusually high yields are often an indicator of an impending cut in the payout.

The last time the sector’s ability to pay dividends was under threat was in 2009, when the financial crisis sent the price of a barrel of oil down into the low $30s. Management of BP and Shell promised to borrow to pay the dividend until prices revived. Luckily, the oil price staged a rapid recovery.

Executives at both BP and Shell are essentially hostages to the dividend because any cut would result in a sharp fall in the share price. However, it is becoming increasingly clear that the oil price will remain at a low level for some time – with cash flows staying subdued. Management has tried to reassure that the dividend is safe – and it probably is in the short term. But if crude prices fall further and stay low, then the boards may be forced to trim payments.

Shell said it’s preparing for a “prolonged downturn” by cutting jobs and slashing billions of dollars in investments. It is also selling assets, which should help support cash flow. Providing the good times return, this could be enough to prevent a catastrophic reduction in its dividend.

Garry White is chief investment commentator at Charles Stanley. Tom Stevenson is away.

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