Crude oil prices have sunk to 15-year lows in the last week, slipping below $27 a barrel, and the mood in the energy sector is starting to turn from worried to panicked. At these bargain basement prices, even the E&P majors are suddenly starting to look more closely at their balance sheets. According Fidel Gheit and Luis Amadeo of Oppenheimer Equity Research, even sacrosanct shareholder dividends may be on the the table later in 2016 if oil prices don’t bounce back soon.
Gheit and Amadeo lay out their argument: “Current projected operating cash flows barely match the preliminary CAPEX guidance for the majors, and when dividends are included, we estimate an average deficit of >50% of operating cash flow this year. E&P companies‘ CAPEX is currently more than double their operating cash flow, and including the dividend, E&Ps could face deficits of >260% of OCF. Benefits from CAPEX cuts, cost reductions, efficiency gains, service cost deflation and improved well performance could help some, but not enough to offset the impact of low oil prices. Current record dividend yields of 6.6% for the majors and of 2.7% for the large E&P companies, and wider projected deficits, raise investors’ concerns about the sustainability of dividends.”
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More on looming crisis in energy sector
The elephant in the room is the huge drop in crude oil prices over the last year and a half. The issue is oversupply related to dramatic growth in US shale oil production (4.5 mmbd) and Saudi Arabia‘s refusal to reduce production. The drop off in prices has been exacerbated by declining global demand due to an economic slowdown in China and higher oil export volume by Iran. The stronger dollar has also helped to keep a lid on oil prices.
The Oppenheimer analysts point out that cash flow is becoming a major problem for companies in the oil and gas sector. They note: “For 2015, we expect operating cash flow to fall by 31% for the majors and by 46% for large E&Ps, led by APA, EOG, HES, CHK and COP. Based on strip oil and gas prices, we expect further declines this year of 18% for the majors, led by XOM, and of 47% for the large E&Ps, led by 88% for COG, 87% for CHK, and 76% for DVN and EOG.”
The report also projects 2015 energy sector reductions in capital expenditures to average 17% for the majors and 36% for large E&P companies, with additional 8% and 23% capex cuts expected in 2016. APA is estimated to make a 57% cut in capex in 2015. Of note, DVN is expected to lead industry peers in capex cuts in 2016 at 41%, followed by MRO and HES.
Finally, Gheit and Amadeo highlight a growing risk to continued high dividend payouts. It is important to remember that the current record dividend yields are due to plunging stock prices, not dividend increases.
The analysts say oil prices need to get back to at least $50 a barrel soon or dividends or going to be slashed: “Dividends currently account for 43% of the majors’ cash flow, including 48% for XOM and 35% for BP, and for 36% of large E&Ps’ cash flow, including 68% for OXY, 66% for DVN and 59% for COP. We believe dividends could be at risk unless oil prices double. The higher the yield, the greater the risk of a dividend cut.”