Last week Royal Dutch Shell did something that would have been nearly unthinkable at the beginning of this year. The company cut its dividend for the first time in 75 years.
This is remarkable considering the ups and downs of the oil industry of the past few decades. Prices have collapsed many times since then, albeit we have never before seen a major benchmark turn negative.
But the COVID-19 pandemic has hit oil demand in an unprecedented way. A few days ago Bloomberg posted an article showing that energy demand has just dropped by the largest percentage since World War II (which was the last time Shell cut its dividend).
That’s true, but in 1945 global oil demand had yet to reach 10 million barrels per day (BPD). In contrast, COVID-19 has sidelined an estimated 30 million BPD of oil demand. Thus, the global oil industry is coping with the largest demand collapse, by far, in its history.
This demand collapse is impacting both refiners and oil producers. Shell, as an integrated supermajor, is both. Refiners often benefit from falling oil prices, because they generally see margins expand. That’s why an integrated oil company is usually more stable during the ups and downs of oil prices. Upstream (oil and gas production) and downstream (refining) generally perform out of phase with each other, which helps balance out the cycles.
But the current collapse is hitting both ends — oil demand and finished product demand. This creates one of the most challenging economic climates the integrated oil companies have faced — perhaps ever.
Norway’s Equinor previously announced a two-thirds dividend cut, and now Shell has followed. Chevron’s CEO has publicly stated that the company has enough cash on hand for now to maintain its dividend, but it will also come under increasing pressure as long as oil prices remain depressed.
The oil producers and the refiners will remain under the most pressure, while the integrated companies won’t be far behind. The midstreams — the pipeline companies — are in somewhat better shape. However, they are no immune to the forces impacting the rest of the energy sector, as Plains All American Pipeline showed when they recently announced a distribution cut.
I think investors should heed the underlying warning in Shell’s first dividend cut in most of our lifetimes. Consider the pressure they must have been under not to break their 75 year streak. That is evidence that they see the current crisis unlike others the oil industry has faced in recent decades. They aren’t sure when oil demand will recover.
Thus, investors should be exceedingly cautious in the energy sector for the foreseeable future. This is especially true of oil-weighted producers, and refiners.
Safer bets are the midstreams and natural gas producers. The latter have shown much greater strength than the oil producers, because associated natural gas production is falling as oil producers shut in production. That means natural gas supplies will continue to tighten in the months ahead.