Investors could be facing a painful hit to their income payouts as the plummeting oil price ratchets up pressure on two major income stocks.
The Brent crude measure of oil shows the black gold has dropped sharply from $115 (£73.30) per barrel in July to just $70 now, putting pressure on the payouts commodity behemoths BP and Shell pass to investors.
Both companies provide two of the largest dividends to investors in the FTSE 100 index, but fund managers expect this accolade could be seriously tested if the oil price stays low.
JPMorgan Asset Management’s James Sutton, a client portfolio manager on the firm’s Natural Resources fund, said he had concerns about the sustainability of the majors’ dividends, even with oil at $100 per barrel. He said these worries had been exacerbated by the oil price fall.
“The extent to which the dividend yields of the oil majors are sustainable is questionable,” he said.
“We had been worried about the majors’ lack of free cash flow to cover dividends when the oil price was $100 plus. If we stay below that level for the foreseeable future, then these dividends will be paid out of debt and balance sheets will be stretched.”
Mr Sutton said many investors were seeking the perceived security of the dividend-paying oil majors because they were seen to be at less risk from falling share prices.
As a result, shares of BP and Shell have fallen by much less than in smaller exploration and production-focused stocks, or even fellow FTSE 100 oil stocks Tullow Oil and BG Group.
He warned “the perceived defensive profile of the oil majors may prove largely illusory” as they struggled to generate cash at low oil prices.
Ben Ritchie, senior investment manager on Aberdeen’s pan-European equities team, said at the current oil price level, he “wouldn’t expect any dividend growth next year from the oil majors”.
Richard Buxton, manager of the Old Mutual UK Alpha fund, predicted the oil price could go as low as $50 based on current supply and demand factors in the market.
He said he thought Shell, which is his second-largest holding, should be able to keep paying its dividend, but he admitted “it’s not going to be easy”.
However, he was “not so convinced” by BP, which in addition to dealing with the low oil price is also facing major headwinds from the legal backlash to its US oil spill and also from its holdings in Russian firm Rosneft.
Broker Canaccord Genuity predicted that if the oil price remained below $80 per barrel for more than one year, then “capex [capital expenditure] budgets across the sector would need to be cut aggressively in order to protect dividends”.
The broker said BP and Shell should be able to maintain their payouts at that price with a small number of spending cuts, but that if it fell to $70 per barrel for a “prolonged” period then the firms would really struggle.