When the oil price slumped, the saving grace for BP and Royal Dutch Shell (LSE: RDSB) was dividends both had the ability to keep paying dividends from other sources should earnings fall for a few years.
Royal Dutch Shell shares have fallen by 42% since their recent peak in May 2014, but thats been offset to some extent by a 5.7% dividend yield last year and theres a massive 7.7% expected for 2015. Its still not a great overall performance, but compared to the way some smaller non-dividend oil stocks have fared, its almost heavenly.
The problem now is oil is still sliding and has dropped further than a lot of pundits expected. Brent crude sank to an 11-year low on Monday of just $36.05 a barrel, although it has perked up a little since then to $36.92 as I write.
The existing market consensus of 120p in earnings per share for Shell in 2015 wouldnt cover the mooted 123p dividend, and thats based on some individual forecasts that pre-date this latest oil price collapse. The next individual forecasts to come out of the City could well indicate even lower earnings than that.
Pressure on dividends
The longer these rock-bottom oil prices persist, the less and less confident the current consensus for an 8% EPS recovery next year will start to look. And thats surely going to put pressure on Shells dividends.
So far, the 2015 cash is looking safe, after Shell confirmed its third-quarter dividend at the same dollar level as the third quarter of 2014. But chief executive Ben van Beurden did point out that dividends have been covered by operating cash flow over the last year, when oil prices have averaged $60 per barrel.
That suggests that for the dividend to be maintained in 2016 we might need to see oil recover to an average price during the year of around that $60 mark, and I really cant see that happening. A rise to $60 or more later in the year perhaps, but I can see prices of around $40 continuing for quite some time in 2016 as supplies are just not falling.
Of course, the company has the ability to pay next years dividend from cash reserves rather than from operating cash if it chooses to, and so far theres actually no indication that it might not. But it would be foolhardy to just assume thats what will happen and that next years dividend will be safe.
In the long term, I reckon energy companies like Shell and BP will still make excellent investments, as China is still growing (just not quite as fast) and there are billions of other people around the world in growing economies and whose energy demands can only keep on rising. And rumours of the death of oil at the hands of renewable sources are most definitely exaggerated at this time.
But if youre relying on that dividend in the short term, you could be taking a bit more of a risk than you really want. Whether it will be cut in 2016 I clearly cant say, but I reckon theres maybe a 50/50 chance of it going either way.
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Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has recommended Royal Dutch Shell. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.