The Dividend Shock of the Century

The impact of Shell cutting its dividend can be seen from so many angles.

A 70+ year record, dating back to the Second World War, for maintaining dividend payments, has been cut.

It must now be removed from all dividend aristocrat funds – which are exchange-traded funds (ETFs) investing only in companies which have grown dividends for a decade or more. That’ll hurt some of the automatic inflows it used to enjoy.

The day of the cut, it felt like one company was dragging the whole of the UK’s major index down with it.

It’s amazing to think of all the crises that it has overcome since then without having to cut its payout – the US has apparently suffered 12 recessions, including the current one, in that time.

The 1974 recession knocked almost 50% off the S&P 500, Black Monday 1987 took 35% off the FTSE 100, and the tech bust and global financial crisis are fresh enough in our minds to need no statistics.

Then you have the oil crises – the 1973 OPEC embargo, the Gulf war(s), and price crashes galore.

Here is a chart of the oil price with US recessions shaded in grey:

Source: MacroTrends

The 1980s saw an oil glut following the energy crisis of the 70s, which saw prices fall by more than half. The financial crisis saw prices fall almost 75%. And still no cut. Nor in 2016 when prices fell by two thirds.

But today, things are different, because loss of demand may more be than a short-term factor.

Criticism is coming in thick and fast for US firms in particular who cling on to promises of rising populations and economic growth sustaining oil demand in years to come. There’s an interesting divergence between the US and European oil majors – the US is tending to back its oil and gas growth projections much more than over here.

But the trend is pretty clear: for the last couple of decades there has been lower oil demand growth – growth being the key word.

Global oil demand growth has been slowing yet still positive, but it’s also quite clearly diverging. In the developed world – OECD countries – demand has been falling steadily for a while now:

Source: ERCE

While the developing world (although I do hate the simplistic two-factor split of world nations – watch this if you have time: the world is far more homogenous than you think) has delivered all of the oil demand growth:

Source: ERCE

Here is the International Energy Agency’s graph showing the two overlapping sets of data:

Source: IEA

And global oil demand growth? The trend is clear: still growth, but slowing growth:

Source: Gregor Macdonald

Then again, there is no cure for low oil prices like low oil prices.

What I mean is, although the overall picture for the substance itself is bleak, and Shell’s cut confirms a darker outlook for the whole industry, this does not mean the game is up for oil stocks for good.

There is potential there, that as all the production cuts and stalled projects filter through in the next few years, demand will pick up to its previous levels, and then the current relationship of massive oversupply might shift to a more balanced one, or one of undersupply.

Especially as oil demand growth spikes in the year or two after a panic like this one.

Anyway, some interesting points or arguments arise from this.

Should oil companies even be paying dividends?

Surely, given the scale of the challenge before them, they should be hoarding all the capital they have so they can spend it transitioning into the future. People think investors want the dividends, but judging by the performance of Equinor and the renewable utilities over the last few months/years, what they really want is a future they can believe in.

Ironically, Shell is actually one of the best at this. Which is why its dividend cut, seen in light of the energy transition, could be a good thing.

It’s already upped its commitments regarding its own decarbonisation plans in the last month, despite coronavirus (CEO Ben van Beurden reiterated that the industry must not lose sight of the long term).

And it’s declared its intention to become a power sector player in the future – generating electricity rather than finding, producing and selling oil. It’s already made one of the more aggressive transitions towards natural gas, which is correctly seen as a vital transitional fuel in the race to decarbonise.

Some go further, seeing it not as a transitional fuel, but as a fuel that can play a role in meeting increasing economic demand without adding to the climate crisis.

Consultancy Thunder Said Energy has modelled what it sees as the best route to a net-zero 2050, and sees natural gas tripling in that time. Its projections for gas demand to 2030 alone are aggressive:

Source: Thunder Said Energy

Shell sits alongside Equinor, BP, Eni, Total, and a few others in terms of its diversification into gas, other fuels, and other business models. Shell especially has been very acquisitive in the renewables and clean tech space, including a purchase of First Utility (a UK-based electricity and broadband supplier with 800,000+ customers).

In the US, it is clinging closer to its legacy businesses of fossil fuel extraction, production and marketing. The experience of the coal companies over the last decade or two suggests this isn’t a wise move.

To finish, it’s worth noting that it’s not just the oil and gas sector cutting dividends.

Dividends have been cut at record rates during this crisis. And in fact, that’s the sensible thing to do, especially if you have overstretched yourself of late.

No matter whether you have been managing your business well or badly, 2020 Q1 and Q2 offer something of a free pass to managements, because cutting your dividend and capex is the sensible thing to do, regardless of whether you need to or not.

Suddenly dividend cuts are not the sign of a declining business struggling to meet its costs, but a sign of prudent management. If you cut, you cannot be judged relative to your peers because everyone is in trouble. Not cutting almost seems reckless.

That goes part way to explaining why companies in the S&P 500 are matching Shell, and cutting their dividends at the fastest rate in decades.

Buybacks too, are being suspended en masse, and given that easy money-financed corporates buying their own stock is seen as one of the key supports of markets in recent years, this should give investors everywhere serious cause for concern.

Source: Man Group

And in the meantime, it’s worth noting that energy, which you might expect to be worst hit in this sense, is only third and generally in line with the pack – its financials (big US banks) that have been forced to cut back the most.

The loss of dividends is a big hit to income investors. The loss of buybacks is a big hit to our chances of capital gains.

Markets today, however? Cheerfully up – and long may it continue I would add… Hope for the best, but prepare for the worst.

Best for now, and enjoy the upcoming bank holiday weekend – and I’ll still send out a Friday edition for you, so keep an eye out for that.

Kit Winder
Editor, UK Uncensored

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