How Safe Are Dividends on Oil Stocks?

How Safe Are Dividends on Oil Stocks?

Dividends are one of the ways that companies reward investors for buying and holding their stock. Dividends are regular payments made to shareholders, usually monthly or quarterly. Companies that pay dividends are attractive to many investors because they provide consistent income, even if the companies' stock value falls. However, dividends are not guaranteed. A company may cut or even suspend its dividend. Dividends are often reduced or even cut completely when a company is undergoing economic challenges, which all oil companies are currently facing.

Oil Prices

West Texas Intermediate (WTI) crude oil prices started their downward trend in 2012 and have fallen dramatically, from above $120 a barrel to under $40 a barrel in late 2015. This has forced oil producers to make drastic cost cuts. For many companies, these cuts have included dividend cuts. Not all companies have slashed their dividends; some have maintained or increased their dividend payments to shareholders. It may not make sense for companies to maintain or increase their dividends when they are struggling with low oil prices, but this is the precise situation in which dividend payments are necessary. Dividends encourage investors to hold or buy the company's stock. Cutting dividends could cause an exodus of shareholders, which would cause stock values to fall even further.

How Safe are Oil Dividends?

Determining the safety of an oil company's dividend payments requires some knowledge of where oil prices are going. Predicting oil prices with certainty is nearly impossible, but there are overall trends. At the end of 2015, prices were depressed by a global oversupply, and there was no indication about when the oil market's fundamentals would change. The Organization of Petroleum Exporting Countries (OPEC) will not decrease production until it has the cooperation of the other major oil-producing countries across the globe. Getting multiple countries competing for market share to agree to reduce production levels is challenging. With this in mind, it could be years before oil prices see a consistent recovery, and weak oil prices will continue to cap oil companies' earnings and their ability to fund dividends.

The Future of Oil Companies' Dividends

Many oil companies have told investors that they are committed to maintaining their dividends even as oil prices remain weak. No matter how badly a company wants to keep its dividend payments, the price of oil is beyond its control. There are two big threats to an oil company's ability to make good on its word to continue to pay dividends to its shareholders: 1) a steep decline in oil prices to an even lower price point, or 2) oil prices that remain low for a protracted time period. Either situation can erode a company's cash and is likely to affect its ability to continue to fund dividend payments for its shareholders.

If the price of oil remains weak for a prolonged period, or if there is another downward slide in the price of oil, then it is worth being cautious about the ability of oil companies to keep paying dividends at their current rate. With oil prices already at a price point where some producers are under water, a steeper decline would put even more companies in unprofitable territory. Just because a company is not profitable does not mean that it will cut dividends; many companies are already using debt to fund dividends. If you want safe dividends in the oil sector, look for companies that have long histories of maintaining their dividends through various cycles of oil prices. These companies are more likely to continue to pay out dividends to their investors, even when oil prices are low.