Royal Dutch Shell (LSE:RDSB) shocked the energy world earlier this month when it cut its dividend in the wake of the oil crisis and coronavirus pandemic. The Shell share price plummeted following the announcement.
Dividend cuts seem normal of late, given the unprecedented times we are living in. Nonetheless, Shell’s cut was surprising because it had an unblemished 75-year record of never having decreased its dividend. Its decision marked a severe change of pace for the oil industry.
Oil price volatility
So why did it do it? Shell requires an oil price of around $36 a barrel to break even. Earlier this year, the price of oil approached $70 and many projections based future earnings on prices in this region or higher.
Several factors then came into play, but the oil price has been below the break-even benchmark for several weeks now.
In the US, the West Texas Intermediate (WTI) oil price is the one that matters, but in the UK, it is the Brent Crude oil price, which is primarily sourced from the North Sea. Brent crude prices have been more resilient than WTI lately, but both tend to rise and fall in tandem. Brent Crude has been as low as $16, and at one point WTI went negative.
The recent area lockdowns and travel bans have reduced global oil demand by nearly a third. Although the lockdowns are gradually being lifted, it is unlikely demand will return to pre-pandemic levels quickly.
Lord Browne, former CEO of BP, recently said he expects WTI could see negative prices again in the coming months as futures contracts come to fruition and the storage dilemma continues to weigh heavily on the US shale industry.
The severe fluctuations in the price of WTI will probably affect Shell’s US onshore production (but it is worth noting that it is the independent oil companies that are most at risk).
Geopolitical tensions
Prior to the coronavirus outbreak, the US and China were embroiled in a trade war. The US had also ramped up tensions with Iran.
Despite the world’s focus being on the coronavirus crisis, these geopolitical tensions are still running high.
And the climate change crisis continues to put pressure on the industry too so oil companies will have to adapt to survive.
Onwards and upwards
Nevertheless, the oil industry is still necessary and will continue to be so for many decades to come (probably on a smaller scale than we are used to, but producing, nonetheless). This makes me wonder, which oil stock is best positioned to survive the turmoil and navigate the choppy waters successfully?
Personally, I think Shell will be fine. The oil price is likely to climb as the US reins-in production. It has a price-to-earnings ratio of 10 which is half that of BP and around a suitable value point as advocated by Warren Buffett.
If you are a long-term holder, with the ability to resist selling when the share price falls and to let the good times run, I think the Shell share price is a good buy.
Although its dividend cut was a shocker, it has a 3.5% yield and a substantial track record. It will have a rough ride ahead, but I think for the long term that Shell will survive.