The world’s biggest energy companies have a tough decision to make amid languishing oil prices: Do they keep their coveted investment-grade credit ratings or maintain century-old practices of paying shareholders annual dividends worth billions in cash?
Exxon Mobil Corp. and its peers are grappling with the collision course between the two, which appears unavoidable as crude continues to hover around $30 a barrel. Even with announced spending cuts that exceed $92 billion, producers are losing money on almost every barrel they take out of the ground. Paying dividends makes their cash shortfall even worse.
Four of the biggest Western oil companies—Exxon, Royal Dutch ShellPLC, Chevron Corp. and BP PLC—are poised to pay more than $35 billion in dividends to investors this year, an amount equal to about 40% of their combined cash flows, says Oppenheimer & Co. To do so, they face increased pressure to borrow, a strategy that has alarmed ratings firms.
“The question is, how bad are things going to get in 2016?” said Simon Redmond, director of oil and gas corporate ratings at Standard & Poor’s Ratings Services. “For a company to focus on continued cash distribution is not credit positive.”
Since the start of the year, all three of the world’s top ratings firms have warned that oil company credit standings are at risk. S&P has already downgraded Shell and Chevron and raised the prospect that Exxon—whose top-tier AAA rating outlasted even the U.S. Treasury’s—could face a downgrade.
Shell, which posted a $1.8 billion fourth-quarter profit, off 60% from a year earlier, reiterated plans to keep paying its dividend this year, helping boost its shares.
Nowhere is the tension more pronounced at the largest oil companies than at Exxon, which has increased its dividend for 33 straight years and made the payouts for more than a century. The company’s bond rating has endured for decades through a number of commodities price crashes, the Valdez oil spill in Alaska’s Prince William Sound and even megamergers with Mobil and XTO Energy.
Exxon is better managed than most countries, said Joe D’Angelo, an energy consultant at investment bank Carl Marks Advisory Group LLC. “For them to have lived through so many hurdles and now this one trips them, you have to stop and think about it.”
A ratings downgrade isn’t the worst thing for most integrated oil companies because they are unlikely to lose access to capital markets or see their financing costs soar. This week Bob Dudley, BP’s chief executive, said a ratings cut wouldn’t have a significant impact on his company.
But ratings cuts would represent a loss of prestige, a sign that the ability of these companies to dominate world markets has diminished with this latest downturn.c
Such promises are essential to luring investors in the face of the worst oil crash in decades. For millions of retirees, who buy stock directly or through investment funds, dividends are a key source of income. Some could see a cut as a betrayal, analysts said.
“To a lot of generalist investors, there’s a view that an investment in Exxon or Chevron is safe,” said Norman MacDonald, a portfolio manager at fund manager Invesco Ltd. The companies are “painted into a corner,” he said.
Oil companies insisting on the payments have turned more actively to spending cuts and layoffs to reduce their cash shortfall, a decision that could threaten their future viability, analysts said.
Some investors target stocks exclusively for growth. As companies expand, share prices often move up as well. Exxon and major oil and gas companies are generally prized for having an ability to pay income as well as grow, albeit at a slower pace.
If oil and natural gas companies don’t spend money to find new fuel reserves to replace what they pump out of the ground, they will eventually run out of opportunities. BP replaced just 61% of the oil it pumped last year with new reserves, while Shell’s reserves declined by 20% in 2015 as it gave up on 1.4 billion barrels of fuel it had expected to develop.
‘We get value from the AAA credit rating in our business...’
The boards of directors at these companies, and at others, should push management teams to reconsider their dividend policies, said Fadel Gheit, an analyst at Oppenheimer & Co. who has repeatedly called for oil companies to reduce the payouts.
“The board has a fiduciary responsibility to shareholders, and right now they are taking money that is needed for the sustainability of the business model,” Mr. Gheit said. “They are cutting the muscle of the company. If you don’t