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Big Oil’s dividends look safe – for now

Screen Shot 2015-01-02 at 23.58.26Big Oil’s dividends look safe – for now

Reuters Breakingviews
Published Tuesday, Jan. 20 2015, 4:40 PM EST

Oil companies don’t like to cut dividends, even when the price of crude tumbles. Dividends are likely to be held firm this year. But the pressure on payouts is mounting.

The halving of the crude price in six months has the feel of 1986. Both then and now, the rout came after three years of relative stability and a surge in supply. Then, the price fell from $30 (U.S.) to $10 a barrel after the Organization of Petroleum Exporting Countries decided not to cut production. It took nearly five years for the oil price to recover fully.

Production is once again not falling fast and demand remains tepid. Industry analysts are starting to expect a similarly slow recovery this time. JPMorgan assumes the oil price won’t reach $90 a barrel until 2019. Goldman Sachs predicts oil will only climb to $70 next year – far from the $100 to $110 range which prevailed from 2011 to mid-2014.

After the 1986 drop, the major oil companies cut capital expenditure by 24 per cent, Morgan Stanley points out. There were also big cost cuts. Morgan Stanley calculates that Royal Dutch Shell PLC, Exxon Mobil Corp. and Chevron Corp. reduced upstream operating cost per barrel by 30 per cent in 1986. Together with improved refining profits, free cash flow actually remained constant that year. Dividends were safe.

This time around, the majors will try just as hard to maintain their dividends. Some have already started axing expensive projects and cutting jobs. They are selling assets. But in some ways they are less well protected than in 1986. In 2014, majors needed oil at $120 a barrel to afford all of their budgeted expenses, according to Goldman Sachs.

There is some wiggle room. European oil majors have an average “gearing” (net debt divided by total equity plus net debt) of 16.6 per cent as of September last year, Bernstein estimates. Allowing this to rise to 25 per cent, the 2009 level, would fund one and a half years of dividend payments at current levels. Shell is one of the more resilient, with gearing set to end 2014 at just 7 per cent, reckons JPMorgan.

But borrowing to pay dividends can only be temporary. Oil bosses will find cuts inevitable if oil stays around $50 a barrel for several years.

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