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Big Oil's Dividends Are Safe… for Now

To say it’s been a wild ride in the energy sector over the last year or so would be an understatement. Prices for fossil fuels have plunged as supplies continue to remain elevated while demand is basically not there. With this supply/demand imbalance, prices for crude oil and natural gas are now sitting at 11-year lows and have finally broke the $40 per barrel mark.

That’s great for consumers and end-users of energy—but it’s not so great for those firms that make their profits drilling and processing crude and other fossil fuels. It’s also not great for their investors.

Big Oil has been a big place for investors to find some big dividends. However, with oil lasting “lower for longer,” many investors are worried about even the ability of some of the largest integrated giants to keep paying their rich dividends.

Truth be told, much of that worry is just that. The vast bulk of Big Oil will be able to keep the dividends humming even in this lower priced environment.

The Problem in an Oil Barrel

The problem for Big Oil comes down to CAPEX spending. When you are a major producer of energy, you need very big projects that span decades to really get the needle moving. After all, Exxon Mobil (XOM ) finding a small pocket of reserves isn’t going to cut it when you’re pulling millions of barrels per day out of the ground. In order to do that, you need to go after elephant finds—and tackling those types of projects cost a pretty penny.

Over the last few years, we’ve seen CAPEX budgets balloon at many of the largest integrated firms.

That’s fine when oil is at $90 per barrel: The costs of investing in these projects make perfect sense as they are very expensive. However, with oil down in the lower $40’s, not so much. And with OPEC’s recent decision to keep on pumping even though prices are that low doesn’t necessarily instill a lot of confidence in starting one of these types of big projects.

It doesn’t instill a lot of confidence in investors either.

High CAPEX costs often come with high debt loads. And while the super majors do have the cash flows to help pay for those debts, lower oil prices have finally begun to take their toll on those cash flows. Over the last year, the four biggest oil companies—XOM, Royal Dutch Shell (RDS-A ) (RDS-B ), BP (BP ) and Chevron (CVX )—have seen their collective earnings tank by more than 70%. That huge drop in profits has some analysts now worried that Big Oil may be in trouble on the dividend front.

Reports have already begun to swoon that BP and CVX, as well as Marathon (MPC ), will need to cut their dividends or face a cash crunch.

Big Oil Is Still Ok for Now

While there is cause for concern, investors in the biggest of the Big Oil stocks can still sleep well at night.

For starters, many of the largest oil stocks have addressed the problem head on. CAPEX spending has been slashed to bare bones minimums while personnel and headcounts have also been reduced. According to BP, more than $22 billion in CAPEX spending has been slashed, while more than 80 big projects have been canceled.

Secondly, the reduction in spending has allowed many Big Oil stocks to cover dividends, buybacks and other shareholder activities via cash flows. XOM managed to generate nearly $8-billion in cash during the last quarter while Shell has covered its payout with cash on hand, cash flows and asset divestitures. Even BP and CVX—the two “problem children”—have created spending plans that use cash flows to cover CAPEX and dividend payments.

Breakeven points for new projects continue to drop to the lower $50 per barrel range. The combination of betting on more sure things and lower oil services costs have helped the majors

Finally, Big Oil does have a slight secret weapon/advantage: It comes from the term “integrated.” Many of the largest oil stocks also own refineries and downstream operations. These businesses actually benefit from lower oil and feedstock costs. While it’s not enough to overcome the entirety of the production side, the downstream/refining businesses have saved earnings over the last few quarters as crack spreads and margins remain robust. Cash flows from refining are helping plug the gap from the E&P side of the business.

Putting It All Together

So while, Big Oil has suffered in the face of lower crude oil and natural gas prices, things may not be as bad as first blush. The major energy stocks have already begun to live within their means in the latest bout of low oil prices. CAPEX and spending reductions, along with other costs saving moves, will help them keep the dividends humming along for the next few quarters.

And that’s what investors need. Ultimately, this low oil price environment is not sustainable over the longer haul. Even OPEC is beginning to suffer and treasury reserves at its key members—Saudi Arabia especially—are being depleted at rapid rates. Eventually, production will get cut and prices will rise.

Big Oil just needs to kick the can until that point. And at the end of the day, they have the ability to do so (at least for now).

For investors who are looking at or already own the majors like XOM, CVX or Total (TOT ), they can rest easy knowing that their dividends are pretty safe—even with oil down in the dumps.