Before you read the rest of this article I’d like to make one thing perfectly clear. Just like mining firms, oil companies’ profits are hugely dependent on the price of the commodity they produce, in this case oil. And it goes without saying that this in turn has a huge impact on the share price of London-listed oil firms. So if the oil price is beyond a company’s control, why would we even contemplate investing our hard-earned cash in such an unpredictable business?
Lovely, lovely payouts
The answer is simple. I’m talking about those lovely, lovely payouts shareholders receive in the form of dividends. Where else can you get regular hefty (legal) payments for doing absolutely nothing at all? Of course not all oil companies are created equal. UK-listed oil majors such as BP (LSE: BP) are not only involved in the exploration of oil and natural gas, but also produce, refine, market, and sell the black stuff on forecourts worldwide.
Not only does this provide the oil majors with a degree of diversity, but also contributes to literally billions of pounds in profits each year, a good proportion of which finds its way to a global army of shareholders. But what about the rest? There are close to 100 oil firms listed on the London Stock Exchange, surely some of them have better growth prospects than industry fossil BP (pun intended).
Black gold
Well, yes and no. Many of these smaller firms are unable to turn a profit in the current low-oil-price environment, while others are hugely indebted. Many are listed on the riskier Alternative Investment Market (AIM), and others don’t produce any oil at all. These firms are still pumping millions of pounds of investors’ money into exploration, with the hope discovering black gold somewhere down the line, or at least that’s what their shareholders are banking on.
Don’t get me wrong, investors have in the past become extremely wealthy backing some of these smaller explorers, whose share prices have exploded on the news of a discovery somewhere on foreign soil or deep beneath the oceans, but by and large they are very risky and highly speculative investments. And it can be many, many years before management can even a hint at a dividend.
Stronger position
BP on the other hand has managed to ride out the oil price crash and sustain its generous dividend during a period when many smaller exploration firms have seen the value of their shares collapse by 90% or more. Cheaper petrol and diesel prices will have provided little consolation for their disappointed investors.
And let’s not forget about the Deepwater Horizon oil spill, where BP has set aside $20bn to settle compensation claims, and yet the company has managed to weather the storm and return to profitability. ‘What doesn’t kill you, makes you stronger’, or so the saying goes, and I truly believe BP is in a much stronger position than ever to take full advantage of any recovery in the oil price from hereon in.
In the meantime, investors can just sit back and enjoy the quarterly 10¢ per share dividend, equivalent to a mouth-watering 6% return. If BP maintains this in its third quarter results next week, I’d expect a fresh wave of buying activity ahead of November’s (yet to be announced) ex-dividend date.