Unprecedented. That could be the best way to sum up the goings-on in the world’s energy market. Hit by a one-two punch of oversupply and a complete collapse of demand, the sector is in turmoil. And with prices for crude oil and natural gas hitting lows not seen in decades, firms that produce oil and gas are being hit hard. So hard, in fact, we could be witnessing a complete “reset” of the sector, full of bankruptcies, losses and even dividend cuts.
And those cuts could even come to some of the big oil majors that were once considered impervious to such measures.
While the long term may be rosy for the sector and some of its players, the near term is very rocky indeed. For those investors looking for steady income, the energy sector continues to be the one to avoid.
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It was only a few weeks ago when the supply and demand figures started to get seriously out of whack. Thanks to the efficiency of fracking technology in the U.S. and the continued production in Russia as well as across OPEC, the world is awash in oil. That fact already started to drive prices lower over the last year as a slowing global economy hit demand.
But with the COVID-19 pandemic causing lockdowns, travel restrictions and shelter-in-place orders, demand for fossil fuels has fallen off a cliff, so much so that prices for crude oil have plunged to levels never seen before.
Last Monday, the front month futures contract for West Texas Intermediate crude oil fell to negative $37.45 per barrel. This has never happened in the history of the futures market. What that negative price basically implies is that producers are paying buyers to take crude off their hands. While international benchmark Brent remained positive, futures contracts still plunged to lows not seen since 1991 and the first Gulf War.
The reason for the negative price comes down to no demand and full storage facilities.
Most of the nation’s oil gets stored in Cushing, Oklahoma. “The pipeline crossroads of the world” features a vast field of tanks and pipeline facilities. Oil comes in, is stored and then flows out again to end users and refineries. The problem is, thanks to the lack of demand, those facilities are full to the brim. And since futures traders, unlike options traders, need to take physical delivery of the commodity, they were willing to do anything to not have to do just that.
It Gets Worse for Oil Stocks
The problem for energy stocks is that demand isn’t returning anytime soon. According to the International Energy Agency, about 9 million barrels a day is expected to be lost in 2020 on a year-on-year basis as the COVID-19 pandemic carries on. April is likely to be hit hard, as demand for the month is expected to be 29 million barrels a day lower than a year ago. However, supply remains robust. Even the proposed cuts from OPEC, Russia and Saudi Arabia would only lead to a reduction of about 12 million barrels a day in May 2020. There’s simply too much oil right now.
You can see by this chart what this is now doing to the next front month futures contract for June. WTI has continued to crater further. Traders are betting that demand won’t be there later either. The chart for July looks very similar.
Source: New York Times
This poses a huge problem for oil stocks. As we’ve said before, the price of the commodity minus your costs equals your profits. Well, when no one wants your product at all or you have to pay someone to take it, you can see the issue at hand.
As a result, energy companies are scrambling. According to consultancy Rystad Energy, global investments in E&P operations are down by $100 billion this year. Energy firms are reducing rig counts, laying off staff and even filing for bankruptcy.
They may need more cash as well. According to Moody’s, E&P firms have about $86 billion in debt that is maturing between now and 2024. Pipeline firms have roughly $123 billion coming due in that time. Moreover, energy stocks have been the biggest issuers of junk bond debt over the last decade.
Which brings us to dividends.
Many energy stocks have no choice but to cut payouts. This has already started. Oil services stock stalwart Schlumberger (SLB) recently cuts its payout to preserve cash. And it’s not alone; integrated giant Occidental Petroleum (OXY), independent firm Continental Resources (CLR) and even pipeline firm Plains All American Pipeline (PAA) are just some of the recent dividend cuts.
You can use our Dividend Screener to find high-quality energy dividend stocks based upon 16 parameters. Stocks with the highest DARS ratings are Dividend.com’s current recommendations to investors.
More Dividend Cuts Could Be in Store
The scary proposition is that none of the supply and demand imbalances seem to be ending anytime soon. That’s a massive issue for the sector going forward, so much so that even once-unstoppable dividends could be at risk.
Yes, the Exxons (XOM) and Royal Dutch Shells (RDS-A) of the energy sector do have strong balance sheets and plenty of cash on hand to keep their dividends going for the time being. However, even mighty XOM can’t make money when oil is at $16 per barrel, or worse, negative.
Depending on just how long the COVID-19 pandemic lasts, even the major oil stocks will need to think about the suitability of paying a dividend. Exxon’s free cash flows have plunged 67% in just a year – and that was before the COVID-19 pandemic took hold.
None of this is great for investors looking for steady income from their holdings. There are just too many moving parts in the energy patch to make this a “stable” income play. There could be value here in some of the larger energy firms, but investors looking for income should take a pass.
The Bottom Line
The historic moves in the energy sector are a precursor to more heartbreak for income seekers. Supplies are still far above any sort of demand and the imbalance isn’t likely to shift anytime soon. That will lead to more dividend cuts and a loss of stable income for investors.
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