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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Dividends For Oil Majors No Longer Sacred

The oil price collapse seems to have stabilized for now, but unfortunately for investors and oil companies, the mid-forties price per barrel of oil is not high enough to allow energy companies to sustain their E&P budgets while also maintaining capital expenditures and dividends. To that end, many smaller oil firms have already taken draconian measures to cut costs. Now, it looks like it’s the oil majors turn.

Royal Dutch Shell, Total, and BP appear poised to begin giving investors the option of receiving dividend payouts in shares rather than cash as a way to preserve the balance sheet. It’s a sign of how bad this crisis is for oil firms that the largest and most secure oil companies are now looking at making changes to their dividends which have long been considered “sacrosanct.” Related: Energy Storage Could Become The Hottest Market In Energy

Firms traditionally see their stock fall substantially when they cut their dividends; just look at what happened to the various offshore drilling stocks on the days over the last year when each announced a dividend cut. Given that reality, it is little surprise that the oil majors are eager to hand out scrip dividends rather than cut the payouts wholesale. Nonetheless, the situation does illustrate an unfortunate reality about firms; they are terrible at managing their own issuance/buyback policies.

A 2014 University of Kentucky study of roughly 5,500 companies by finance professors Alice A. Bonaime, Kristine W. Hankins and Bradford D. Jordan found that while the average annual return on buybacks was 7.7 percent, companies would have gotten gains of 2 percentage points more per year had they not tried to time the market and bought shares at a constant level quarter to quarter. Related: Political Climate Shifting Against The Oil And Gas Industry

The results from that study are directly applicable in this situation; in essence, big oil companies did not stockpile enough cash in good times and now they are being forced to issue stock at depressed prices. In the future, when oil prices rise again, these firms and many other across the energy space will look to buy back stock, but by that point, prices will be inflated. As the study’s authors wrote: “Given their inside information and experience, managers should be able to add value through strategic repurchase timing, buying when share prices are low … Yet, we find that companies are more likely to execute a repurchase in quarters when stock prices are higher.” Related: Apache Resists Unsolicited Takeover Bid

Oil majors will retain billions in cash at a tough time in the markets by switching to scrip dividends, but issuing new stock now will dilute earnings per share in the future, and limit the company’s ability to issue future shares at a time when the capital raised could be used to fund growth plans. The reality is that the companies belong to shareholders and so, to the extent that these oil majors are simply issuing shares in proportion to the amount of stock held by each shareholder anyway, there are no real effects from the issuance.

The problem occurs because some stockholders will feel it necessary to sell the shares they receive since they don’t get a dividend. This, in turn, changes the ownership structure of the firm and hurts shareholders. That’s especially true if the oil majors ultimately switch all dividends from merely the option of share dividends in lieu of cash to required scrip dividends.

By Michael McDonald of Oilprice.com

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