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News

Trouble in the Oil Patch

Evan Cooper Aug 04, 2015


The past couple of days have not been kind to the oil business. Last Friday, giants ExxonMobil Corp. (XOM ) and Chevron Corp. (CVX ) reported the lowest profits in a decade. The profit slump, of course, is due to lower oil prices which slid again Monday; Brent crude oil futures fell below $50 a barrel, their lowest level since January, and West Texas intermediate — the U.S. benchmark — fell to $45.17 a barrel, the lowest since March 19.

While drivers can’t help but enjoy what will become lower prices at the pump, dividend-oriented investors can only look at the energy industry’s current and expected supply-demand-earnings matrix with queasiness. Simply put, if supply continues to grow, and demand remains stable or declines due to recession or greater conservation and efficiency, it’s highly doubtful that the oil industry will be able to sustain its strong record of generous dividend payments.


Downward Price Pressure


The news on many fronts points to lower oil prices for the foreseeable future. If international sanctions are lifted as a result of the imminent nuclear deal with Iran, that nation is poised to boost oil production almost immediately, according to the country’s oil minister on Iranian state television. And since Saudi Arabia is increasing production, and other OPEC members are unlikely to cut back production to compensate for the Saudi and Iranian increases, the downward pressure on oil prices will only increase. And that’s not counting the huge amount of oil the U.S. now produces through fracking.

Adding to the pressure is the troubled Chinese economy. While China remains a major oil importer, a slowdown there will put downward pressure on consumption.

Also acting as an oil price depressant is the strong U.S. dollar, which will only get stronger if the Fed hikes interest rates later this year. Sure our economy is tepid and our national financial foundation is rickety at best, but since we are in the least worst financial shape of the major Western nations (a scary state of affairs), the world believes the dollar to be a safe haven. So if interest rates rise, even more money will flow here, making the dollar stronger and oil, which is priced in dollars, even more expensive for non-U.S. buyers — driving down demand even more.


Time for Caution


Investors look at all this and see every reason to sell their oil stocks now before conditions worsen. Lower prices, of course, translate into higher dividend yields, and current yields in the sector are juicy. At ExxonMobil, for instance, investors can earn a 3.7% yield, while Chevron pays an even sweeter 4.7%, and BP an astonishing 6.6%.

Being the cheapskate and income nut that I am, I have to restrain myself from tanking up on oil stocks, even if the investment “tank” I’m working with is about the size of the reservoir in a Matchbook car. Now is the time to sit tight.

If industry conditions worsen, share prices will come down more. And if low oil prices persist, the oil companies will face enormous pressure to cut dividends to conserve cash. Either way, investors should feel no urgency to snap up oil stocks for a hefty dividend that could very well become less hefty very soon.

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