Can Chevron Corporation (NYSE:CVX) get past low oil prices and its financial troubles to continue paying its shareholder dividends?
Not likely, according to a recent report by Jefferies Group LLC. And it’s not the only major oil company under pressure. (Source: Bloomberg, last accessed August 13, 2015.)
But is a reported $60.0 billion reduction in capital expenditures this year enough to allow limping oil producers to pay their investors? Crude oil prices are currently wallowing at a six-year low, prompting continued spending cuts across the global energy sector.
The largest international oil producers will have to slash an additional $26.0 billion from their investment budgets if they are to honor shareholder commitments, and to reduce spending by at least 10%. The reported $60.0 billion includes both capital expenditures and operating expenses.
But this is only the beginning, not part of a momentary re-structuring. Analysts are predicting over $180 billion in additional budget reductions over the next few years. (Source: Oilprice, last accessed August 13, 2015.)
Energy producers are digging in for the long haul as slumping oil prices become the new normal, with West Texas Intermediate hitting a six-year low on Tuesday amid volatile global market developments in Asia and Europe.
Despite it’s poor financial performance and high exposure to upstream volatility relative to its peers, Chevron is plunging ahead with a planned $54.0 billion liquid natural gas (LNG) project in Australia. (Source: Chevron, last accessed August 13, 2015.) Different companies however have implemented a variety of financial plans. Royal Dutch Shell plc (NYSE:RDS-A), for example, has cut spending by a shocking 20% this year, promising further moves if they become necessary. (Source: Bloomberg, last accessed August 13, 2015.)
The reality of creating budgets for multi-billion dollar oil companies with projects often stretching for many years is that it is difficult to react to sudden swings in oil prices. Even in the best case scenario, financial decisions at the highest level lag market conditions by several months. Chevron is learning this harsh lesson, as its current budget is based on outdated projections for oil to be $10.00 higher than it currently sits.
Oil Price Forecast 2015
Of course, large integrated oil companies have contingency plans for sudden low price environments. But something of this magnitude?
Brent crude will need to be at $82.00 per barrel next year in order for oil majors to balance cash flow from investments, according to one analyst at Jefferies Group. (Source: Bloomberg, last accessed August 13, 2015.)
To illustrate how sensitive company balance sheets are to price changes, consider the following. For each $1.00 shift in the price of Brent, Shell’s pretax profit is affected by approximately $330 million, and BP p.l.c. (NYSE:BP) is affected by $300 million. Chevron would fare the worst, being hit by around $350 million.
Now, start counting how many dollars oil prices have slid in only a few short weeks and you’ll begin to understand why oil companies’ CEOs are sweating. You would think that top planners at Chevron would at this point start to scale back their dividend payments, but the company is actually following its peers and increasing them.
Despite underperformance across the board, Chevron’s dividend yield rose to 4.7%, Exxon Mobil Corporation’s (NYSE:XOM) to 3.7%, and ConocoPhilips’ (NYSE:COP) hit 5.7%. (Source: Yahoo Finance, last accessed August 13, 2015.) In a broader stock market with an average two percent yield and 10-year treasuries falling to 2.2%, oil majors’ dividends are increasingly out of touch with reality. Indeed, concerns have been raised for weeks now about the question of dividend payments, with Chevron in particular being scrutinized for poor earnings performance. (Source: MSNBC, last accessed August 13, 2015.)
Why Are Oil Dividends So Disconnected From Reality?
Of course, industry prestige is on the line. Exxon Mobil has paid robust dividends for more than a century, and Shell hasn’t cut dividends since 1945. When you feel the momentum of history behind you, no CEO wants to have that failure as their legacy. But the dual-strategy of maintaining healthy and growing dividend payments while under extreme pressure to trim your budget is an unsustainable policy.
How is Chevron Managing to Pay High Dividends?
The company paid $4.0 billion in dividends in the first half of 2015, on top of $15.2 billion in capital expenditures to maintain production. How was all this funded? Through $9.5 billion generated from operations, almost $5.0 billion in asset sales, and $4.1 billion new debt. (Source: Yahoo Finance, last accessed August 13, 2015.)
Think about that for a second. A major international oil producer is selling off assets and taking on debt simply so it can continue paying out fat dividend checks. And it’s not the only one.
With an oil price rebound nowhere on the horizon, how much longer do you think this game can go on for?