[LONDON] As Europe's top oil companies make deeper retrenchments due to slumping oil prices, their generous dividend policies are coming under closer scrutiny.
Royal Dutch Shell, Total and BP are among those set to report dismal earnings next week for the last quarter of 2015 when oil prices averaged $43 a barrel, down more than 40 per cent from a year earlier.
Those prices mean company boards have little choice but to cut spending, crippling growth prospects.
And as income shrinks, companies can only borrow more in order to maintain their commitment to pay out dividends. Low debt levels mean that for now they are able to maintain unchanged dividends.
But the pressure is high.
Average dividend yields - the dividend payout relative to the share price - soared over the past year to an all-time high of above 7 per cent as share values have shrunk.
Shell's yield rose to above 9 per cent from around 6 per cent in 2014 while BP's is above 8 per cent from around 6 per cent, which according to UBS are "levels usually associated with inevitable cuts".
In 2015, Europe's oil majors paid around US$27 billion a year in dividends, which have been an investment cornerstone for decades. Shell and BP alone account for 10 per cent of the FTSE 100 total dividends in 2014, according to Macquarie.
Charles Whall, portfolio manager at Investec Asset Management, said oil companies' flexibility to borrow and an underlying confidence in an oil price recovery means they should maintain dividends. "More importantly, these (dividend) levels will keep the pressure on the majors to prioritise projects and not to fuel another OFS (oil field service) inflation spiral," said Whall, whose portfolio holdings include shares of several majors including Shell and BP.
"A focus on returns rather than growth should allow these companies to outperform in what is likely a low-growth world." UBS analysts sees dividends at Norway's Statoil and Austrian group OMV as the most vulnerable. Analysts at Barclays also said OMV's dividend appeared increasingly at risk.
A spokesman for OMV, which announced on Friday it was forced to take write-downs totalling 1.8 billion euros, said "so far nobody has changed the target of a 30 per cent payout ratio (of net income)".
Statoil, whose exposure to the oil price is bigger than many of its peers, has repeatedly said its dividend policy remained firm.
Italy's Eni is the only European major to have cut its dividend, while Shell, which is set to complete its US$51 billion acquisition of BG Group next month, has vowed to maintain its dividends.
But with oil prices still languishing near their lowest levels since 2003, companies might soon run out of options. "The longer you've got low oil prices, the more companies will have to focus on pure survival. Even for the long-term players, this is becoming the harsh reality," said Macquarie analyst Iain Reid.
"If oil prices stay at $30 a barrel over the next few quarters we will reach the stage where the pressure to cut dividends will become very difficult to resist. Companies will say 'Do we really want to sacrifice all future NPV (net present value) growth for our dividends?'." Analysts expect a shift in executives' messaging on dividends in the upcoming earnings. "Dividends, supported by scrip, are expected to remain intact in 2016; however, we expect the 'sacrosanct' messaging to be distanced as the impacts of a near $30 a barrel price environment are realised," BMO Capital Markets analyst Brendan Warn said in a note.
Next week's results are expected to see another sharp drop in income, with companies set to announce further capital expenditure cuts, asset sales, job cuts and costs savings. "The companies have positioned themselves for $60 a barrel for this year, now they will have to position themselves at lower than $50 a barrel," said Macquarie's Reid, who expects a total of US$15 billion in new capex cuts.
Global oil and gas investment in 2016 is expected to fall to its lowest in six years to US$522 billion, following a 22 per cent fall to US$595 billion last year.
Refining and trading operations, which offset a large part of profit declines from oil and gas production, is set to once again come to the rescue, albeit less than before as global demand eased at the end of last year, according to analysts.