Why BP’s dividend remains highly uncertain

The oil price collapse which began in 2014 has not exactly been good news for BP’s share price. More importantly, cheap oil has also seriously undermined BP’s dividend.

For now, the company has maintained the dividend, but how long can that last in the face of dwindling revenues, profits and cash flows?

Death, taxes and BP’s dividend

In the good old days, BP’s dividend was about as certain as death and taxes.

For decades, cautious and income-seeking investors could rest safe in the knowledge that every quarter a new dividend would be paid, and that most of the time it would go up ahead of inflation.

That happy picture was well and truly smashed in 2010 when the Gulf of Mexico oil spill led to BP’s dividend being suspended for three quarters. When it was finally reinstated, it was half the dividend it used to be.

But in the wake of that disaster, BP managed to pull off a near-miraculous recovery, driven by a mixture of asset sales on a massive scale (around $75 billion since 2010) and a supportive (i.e. high) oil price.

The post-disaster recovery has been so successful that today the dividend, on a per-share basis, stands almost level with its all-time high from 2009.

However, after the oil price collapse, the company’s dividend is no longer covered by underlying profits or free cash flows, which means that unless the situation improves the dividend is not sustainable at its current level.

BP plc financial results to 2015
BP’s dividend is now seriously at risk (again)

Dividend uncertainty in the short-term

Fortunately, there are ways and means by which companies can maintain their dividends, even if they are not currently affordable.

For example, companies can reduce cash outflows by reducing capital expenses or by simplifying the organisation to make it more cash efficient. Alternatively, they can generate additional cash by selling off less profitable operations.

BP’s proposed financial framework for 2015-2017 makes use of each of those actions in order to balance the company’s sources and uses of cash over the next few years.

Even with all of those actions, the company’s cash flows will only sustain the current dividend if oil is priced at $60 per barrel or above (today the oil price is below $40). If oil doesn’t reach that level, or if the plan is not successful for some other reason, it is very likely that the dividend will be cut.

So the question is: how likely is it that oil will be back above $60 per barrel by 2017?

The unfortunate answer to that question is that nobody has a clue. Much like the stock market, forecasting oil prices in any meaningful way is simply impossible.

If it was possible then everybody would have known that oil prices were about to collapse in 2014, which of course they didn’t.

So the future of BP’s dividend over the next few years is about as uncertain as the oil price, which means that it is very uncertain indeed.

But as a long-term investor, I don’t mind a little short-term uncertainty, especially if it means I can buy companies at low prices and with high dividend yields.

All I have to do then is wait until the economic environment or the company turns around and hey-presto, the shares will be re-rated upwards. That re-rating will provide a nice capital gain on top of the substantial dividend yield.

With BP’s share price at 341p, its dividend yield is currently almost 8%, so clearly a dividend cut is already priced in.

So can investors buy BP today, take any dividend cut on the chin, and then wait for the inevitable rebound in oil prices and subsequently BP’s dividend and share price?

I’m not so sure.

Dividend uncertainty in the long-term

You should take what I’m about to say with a large pinch of salt as I do not have a functioning crystal ball; but here are a few reasons why BP’s dividend could see a permanent decline from where it is today.

The main problem is that today’s low oil price environment could be here to stay.

So far the oil price decline has been largely driven by additional supply from US shale oil and fracking.

But in the longer-term low oil prices could be driven by a mixture of additional supply – as exploration and extraction technologies improve – and reduce demand.

Why would demand reduce in a world of increasing populations, increasing urbanisation and an increasing consumerist middle class?

There could be many reasons, but a mixture of energy efficiency gains throughout society and government policies relating to climate change are among the most obvious.

For example, in a recent speech (available as a PDF file here), Spencer Dale, BP’s chief economist, said:

“In BP’s Energy Outlook 2035, which looks at energy trends over the next 20 years or so, the EU’s consumption of oil in 2035 is projected to be back down to levels last seen in the late 60s, even though EU GDP would have almost quadrupled over the same period.”

And Andrea Leadsom, the UK’s energy minister, said recently:

“The government believes that we will need to take the step of enshrining the Paris goal for net zero emissions in UK law. The question is not whether but how we do it.”

In a world of increasing supply, and demand which eventually stagnates and declines, BP may have no ability to raise its dividend above the current level, no matter how long investors wait.

Despite this uncertainty my portfolio still holds BP

While I do think BP’s future growth prospects are likely to be poor and that the company’s future is highly uncertain, I also think that at the current price and with a current dividend yield of almost 8%, the stock is fairly attractively valued.

That’s why BP is still a holding in the UKVI model portfolio, which it has been for several years.

The position is relatively small though at just 2% of the portfolio. For me, that’s the best way to take on a few of these high-risk, high-yield positions and still sleep soundly at night.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

4 thoughts on “Why BP’s dividend remains highly uncertain”

  1. Keep it John, Spencer Dale’s comments are about as useful as a stud rocking horse, he’s an economist fercryinoutloud.

    I’d bet that oil usage will continue to increase at > 1% a year from here on in. The growth in it’s use in China alone is enough to justify it. Given that China must train 20,000 pilots by 2020 I’d say they are planning on using a lot, and they might need a few Trent engines to go with it.

    No one really knows as you pointed out.

    Provided BP is no more than a couple of % of your portfolio it’s a reasonable bet.
    I opted for BG/Shell recently, but the principle is similar. Anyhow you can get a goodly % back with the dividend in the next year or so, before a cut takes hold.


    1. Hi LR, I’m pretty sure BP will stay in the portfolio for a while yet. I hate selling out of favour stocks unless they really are basket cases, which I don’t think is a fair description of BP.

      This is certainly the most interesting part of the market though, with potentially big profits and losses on offer and nobody really having a clue as to how it will work out.

      I shall stick to having just a toe in the water.

  2. I find another attraction in BP that is very subjective. Their demonstrated ability to adapt and change to new and outwardly disastrous situations. This elephant does appear to have learned to gallop, at least away from fatal experiences if not in the direction of a higher share price.

    If Oil prices rise in the future then no problem, but if Oil does stay low in price many oil companies will succumb, I see BP as a survivor and in the long term that might translate to more value.


    1. That’s an interesting metaphor! To some extent experience of past disasters/recessions/etc is one of the reasons why I like investing in long-lived businesses. They have been around the block many times and should have many employees who are old and bald and can provide experience that their younger more energetic counterparts might lack (although that’s not always the case as the old bald guys in charge of the big banks were often the ones driving their companies off the cliff).

      Oh, and some of the photography on your blog is fantastic.

Comments are closed.

%d bloggers like this: