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Rakesh Upadhyay

Rakesh Upadhyay

Rakesh Upadhyay is a writer for US-based Divergente LLC consulting firm.

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Are Oil Dividends Worth it?

Are you tempted by nice dividends such as BP’s 7.53 percent and Shell’s 7.31 percent? Long-term investors are. They’re lapping up the oil majors on dips to cash in on their impressive dividend yields in hopes that the massive rally in crude oil from the lows of $27.10 per barrel is an indication that crude has bottomed out and higher prices are around the corner.

The large investors are pursuing the oil majors for their stability and safety, which has boosted their prices, but even after the rise, prices remain below their 2015 highs.

The oil majors are expected to report poor numbers this earning season. Jefferies’ equity analyst Jason Gammel believes that the “1Q16 reporting period looks set to be even worse than what we thought was already an especially ugly 4Q15." Related: Despite Claims, Ukraine Not Free Of Russian Energy Dependence

The U.S. Energy Information Administration (EIA) has forecast an average price of $35/b in 2016 and $41/b in 2017, which is well below the 2015 average of $49/b.

Though the oil companies have cut costs and scrapped investments for the future projects, an average price realization of $41/b by 2017 will test their resolve to continue paying high dividends.

Under such circumstances, is buying the oil majors a smart strategy?

The stock market is forward looking. Analysts and investors always focus on the future prospects while valuing a company. And there are, in fact, a couple of points in favor of the oil majors. Related: China Stockpiling Oil At Highest Rate In Over A Decade

The worst in terms of oil prices is behind us. Oil demand remains robust whereas production is decreasing. The supply glut is likely to ease considerably by the year’s end. All of this is positive news for the oil companies.

Consider the dividends of the oil companies, BP at 7.53 percent, Royal Dutch Shell plc at 7.31 percent and Total S.A. at 5.65 percent. In a world of negative interest rates, these are tempting yields for the long-term investor—and if oil prices continue to move higher in the future, the current prices will prove to be a steal.

So what are investors to do?

The answer depends somewhat on your investment objective, but generally speaking, any investor buying into the oil majors for their dividend yield should be ready to face disappointment in the near future. Related: It Isn’t Just ISIS that Is Destabilizing Iraq

Italy's Eni reduced its dividend by 30 percent in 2015. Spain's Repsol cut the dividend by 20 percent for 2015, compared to its pay out in the previous three years. ConocoPhillips cut its quarterly dividend from 74 cents to 25 cents, for the first time since 1991, which is proof that the yields might not remain at the current levels going forward.

Even BP has cautioned that paying out dividends is no longer their priority. Experts are divided on the prospects of Shell maintaining its dividend going forward.

Hence, sustaining the dividend yields in the future will depend on the price appreciation in crude from the current levels. If crude oil prices average closer to the EIA forecast, chances are that dividends will take a hit, but if prices appreciate considerably from here, investors will be handsomely rewarded for their risk.

Investors having a strong gut to withstand the volatility in crude oil prices and willing to accept lower dividend yields in the future should buy oil stocks on declines.

By Rakesh Upadhyay for Oilprice.com

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