The Death Of Oil Dividends

1. Big Oil dividends at risk

- The collapse of oil prices puts dividends at risk. Equinor (NYSE: EQNR) became the first large oil company to cut its dividend, slashing it by two-thirds this week from $0.27 per share to just $0.09.
- There is going to be tremendous pressure on dividends of other oil majors, who have seen their yields spikes as their share prices nosedived this year.
- As a group, the five majors - BP (NYSE: BP), Chevron (NYSE: CVX), ExxonMobil (NYSE: XOM), Royal Dutch Shell (NYSE: RDS.A) and Total (NYSE: TOT) - barely covered their dividends with cash flow in 2019. Brent averaged $64 per barrel last year.
- ExxonMobil has borrowed billions of dollars in recent weeks, suffered credit downgrades, and has steadfastly refused to touch its dividend. "A dividend that erodes the balance sheet, thereby raising the risk premium, stops being a down-payment on value and ultimately becomes a drag on it," Liam Denning writes in Bloomberg Opinion.

2. Consolidation set to hit U.S. shale

- The oil industry "delivered its best corporate returns in periods of consolidation, financial tightening and rising barriers to entry," Goldman Sachs said in a research note.
- "We believe this environment (and shareholder pressure for de-carbonisation) could engender a similar phase of consolidation and capital discipline, as in the late 90s," the bank said.
- After the 2014 downturn, consolidation swept over various oil sectors - offshore, LNG, Canadian oil sands and North Sea.
- U.S. shale has been the lone holdout, with a reading on the Herfindahl index - a measure of competition and concentration - of less than 3 percent, indicating a larger number of small companies. By comparison, offshore has fewer companies, each controlling a larger share of the market.
- Goldman Sachs said that "fragmentation and largely scattered, non-contiguous shale acreage" is a "key reason why shale breakevens have not improved since 2016."

3. Ethanol plunges

- As demand collapses and refineries cut back on gasoline processing, ethanol is also getting badly hit.
- While other agricultural commodities have largely held up, ethanol (and corn) are tied to gasoline demand.
- "Front-month corn futures have fallen to four-year lows and we see further downside risk," Standard Chartered wrote in a report. "With almost 40% of US corn production going into producing ethanol, weak gasoline demand has substantial implications for corn demand and prices."
- For the week ending on April 10, U.S. ethanol output fell to just 570,000 bpd, a record low since data collection began in 2010.
- The corn sector is in crisis, and faces another headwind. Oil refiners are demanding the EPA scrap blending requirements because of their own financial crunch.

4. WTI's negative plunge

- As the May WTI contract neared expiration, prices cratered to -$37 per barrel on Monday, the first time the contract ever closed in negative territory.
- But the problems are not over and there are fears of a rerun. Marex Spectron, the commodities broker, said it would restrict customers from taking positions in the June contract in an effort to shield itself from volatility.
- "Liquidation of existing positions is permitted," Marex said, according to the FT.
- "There are increasing signs that Monday's massive slump in the price of the WTI May contract, though partly the result of increasingly tight storage capacities at Cushing, was due above all to technical reasons," Commerzbank wrote in a note. "It appears to have been preceded by an extreme increase in speculative interest among retail investors in recent weeks; they were lured in by what appeared to be low prices, prompting them to invest billions of dollars in commodity derivatives."

5. Natural gas rallies on WTI's collapse

- The U.S. natural gas futures curve has rallied, coinciding with the meltdown for WTI.
- "This sharp negative move in WTI has increased the market's confidence that significant amounts of associated gas production might be curtailed in the coming weeks as US crude oil production gets increasingly shut-in," Goldman Sachs wrote in a note.
- The oil shut ins - on the order of 1.5 mb/d in the next month and a half, the bank said - will result in the curtailment of 5 Bcf/d of natural gas.
- However, the upside to gas is offset by less coal-to-gas switching.
- Goldman maintained its forecast 2020/2021 winter and 2021 summer NYMEX forecast at $3.50/MMBtu and $3.25/MMBtu, respectively.

6. Gold outperforms during COVID-19

- Holding true to its status as a safe haven asset, gold prices have rallied 12 percent since the U.S. Federal Reserve began a massive monetary expansion in the last few months.
- "More recently, gold prices have continued to post a robust run, with returns broadly outpacing other major asset classes year-to-date," Bank of America Merrill Lynch wrote in a note to clients.
- As the bank notes, unlike oil or natural gas, gold is "not constrained by storage dynamics and its price is not necessarily mean-reverting to the marginal cost of production over the long run."
- Still, gold has a physical settlement, which separates it from other safe haven assets. The margin between futures and physical prices "has blown out" as of late, Bank of America said, in part because of travel restrictions.

7. Retail investors make massive mis-informed bet on oil

- Many retail "are being misled by what appears to be a low oil price: in the hope that prices will rise, they are now buying up shares in exchange-traded oil ETFs on a massive scale," Commerzbank noted in a report.
- "At 550,000 contracts of 1,000 barrels each, net long positions in oil ETFs as registered by Bloomberg have reached their highest ever level," the bank said on Monday.
- But ETFs are not like physical oil. Instead they are individual futures that need to be rolled over each month.
- But the upward sloping contango shape to the futures curve ensures that the ETF needs to roll into more expensive futures contracts with each passing month. The "negative roll yield" erodes returns. Average investors have not grasped this fact.
- The U.S. Oil Fund (NYSEARCA: USO) is one of the most popular ETFs suffered heavy losses in the past week, despite a huge inflow of money.