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Is Change in Payout Strategy Need Of the Hour for Big Oil?

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Oil prices have tanked in recent weeks, crashing more than 65% since January 2020 to the low $20s a barrel amid fears of slowing global economic growth and ample supply. The world’s appetite for energy has been massively hit since the outbreak of novel coronavirus. With 3 billion people in lockdown, International Energy Agency (IEA) reckons global oil demand will witness a drop of 20% in the near future. Further, the fallout between Russia and Saudi Arabia has resulted in a supply glut of crude oil and sparked off a relentless price war, depressing prices further and hurting the global energy industry.

Top oil and gas giants offer stable dividend payouts, a strategy to maintain the appeal of the stock among investors. However, as the world fights a pandemic, top energy companies will have to reassess their payout strategies, either by slowing down share buybacks or reintroducing non-cash dividends.

Re-modelling of Strategies a Pressing Priority

Many oil companies had cut expenses during the 2014 oil downturn, which was driven by supply factors, including booming U.S. shale oil production and shifting OPEC policies. Oil majors like TOTAL S.A. (TOT - Free Report) and Royal Dutch Shell (RDS.A - Free Report) issued scrip dividends after the last slump, which enabled them to issue dividends in the form of shares rather than cash.

Let’s see how these companies are dealing with the oil downturn this time around.

The latest fall in crude has led several oil giants to slash their 2020 spending plans. Supermajors like Shell, TOTAL and Chevron (CVX - Free Report) have rationalized their planned capital budgeting for the current year to weather the crisis.

Shell plans to trim its 2020 capital spending by a minimum of $5 billion from the past projection of $25 billion to $20 billion along with material reductions in working capital. It further plans to cut operating costs by $3-$4 billion over the next 12 months. Shell has also suspended its $25-billion share buyback plan.

TOTAL has decided to lower its 2020 capital expenditure guidance by nearly 20% to less than $15 billion from the prior $18 billion.

Chevron has trimmed its 2020 capital spending guidance by 20% to $16 billion and aims to lower its run-rate operating costs in excess of $1 billion by this year-end. It has also suspended its $5-billion share repurchase program to weather the weak crude pricing scenario.

Italian energy firm Eni (E - Free Report) has downwardly revised its 2020 capital budget by roughly €2 billion, representing 25% of its total budget. The Zacks Rank #3 (Hold) company has also decided to cut operating expenditure for 2020 by almost €400 million. Earlier this month, it even rolled back its €400 million stock repurchases plan.You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Equinor ASA (EQNR - Free Report) has revised its capital budget this year to $8.5 billion from the earlier $10-$11 billion.

With the above measures, the companies are expecting to balance their books, generate enough free cash flow and put a check on escalating debt levels. But none of them have announced dividend cuts yet. Morgan Stanley reckons oil majors’ debt level will rise too high by 2021. “Much remains uncertain, but if commodity markets evolve as expected, we think European majors will start to reduce dividends in the second half of 2020,” says Martijn Rats, Morgan Stanley analyst.

Conclusion

The market has had to deal with twin shocks of the coronavirus pandemic paralysing global energy demand and the unexpected oil price war that erupted between producers Russia and Saudi Arabia earlier this month. Oil majors have time and again expressed their reluctance to cut dividends in order to retain investor interest in the sector, which has suffered a setback due to concerns of long-term sustainability as the world seeks to curtail its use of fossil fuel. The top five oil majors-Chevron, TOTAL, BP plc (BP - Free Report) , ExxonMobil (XOM - Free Report) and Shell-added a combined $25 billion to debt levels in 2019 to sustain capital spending and return huge amounts to shareholders.

Although we expect the companies to be able to sustain their payout in at least 2020, in order to sustain it, they will have to review their costs and deepen operational and capital expenditure cuts. If energy giants do not reduce their payouts, they might have to resort to debt.

Oil markets have experienced significant volatility and price declines amid concerns over the economic effects of coronavirus. However, oversupply of oil and slack in demand should not last forever, and once the economy regains momentum, the question to cut dividend payouts will hopefully not arise. Yet, the question on the affordability of such generous returns due to high levels of debt and growing crisis remains pertinent.

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