With the price of Brent Crude oil hanging on to a sliver over $30 per barrel as I type, I have to say that I still have no idea when the price will stop falling.
As we can see from the chart below, the black stuff has fallen over 50% in the last 12 months, and although the price hasn’t fallen in a straight line (prices rarely do), the general trend has been down.
Again referring to the chart below, and perhaps the understatement of the week, the weakness in the oil price has caused a lot of pain in the sector. That has meant some smaller, pure exploration plays going out of business, while leaving the larger vertically integrated players like BP (LSE: BP) and Royal Dutch Shell (LSE: RDSB) with a headache that the management teams would rather not have. This has caused investors a headache too with tumbling share prices and a weak FTSE 100 also caught up in the chaos owing to its overweight exposure to resource stocks.
How low can you go?
With the price around $30, how much lower is there really to go? That’s the million-dollar question! I can see the price lurching in either direction.
On the one hand, there’s still a huge over-supply in the market, which is providing negative pricing pressure. I think that there are a lot of moving parts to this equation, which I don’t propose to discuss further here, but that is essentially my view.
On the other hand, you only have to look at the precarious position of Saudi Arabia, politically and in respect to the tensions between that country and Iran, coupled with the ever-present threat of IS across the Middle East. To me any adverse developments here could send oil prices racing upward.
Dividend cover’s looking thin
For now, though, I believe that the dividend cover at both BP and Shell is looking precarious. Both companies are forecast to have a dividend cover of less than 1 times earnings for the year ending in December 2015. That’s less than satisfactory, but for businesses of this size, as long as the pressure on earnings dissipates going forward, there shouldn’t be a problem.
However as we’ve seen, oil has halved in price over the last year. If prices were to stay at these levels for a prolonged period, I think management would have little choice but to cut or cancel the dividend for a period until prices recovered.
Personally, while I suspect it’s a rather unpopular choice, I think both management teams should bite the bullet now and rebase the dividend by around 50%. Even then the shares would yield almost 5% and that’s not to be sniffed at in my view.
I would rather see this issue addressed now than being forced on management should prices weaken further – in the long run it’s best for all concerned, I think.