Friday 1st May 2020
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When the boss of Royal Dutch Shell Plc slashed his dividend on Thursday, he didn’t just shock investors. He tore up the industry’s financial playbook.
For decades Big Oil has used the strength of a large balance sheet to borrow money when the going gets tough and keep investors sweet until the next upward cycle.
As the coronavirus pandemic potentially causes lasting damage to energy demand, Europe’s largest oil company asked whether this strategy is sustainable.
“I would say no,” said Shell Chief Executive Officer Ben van Beurden. “It’s also not wise and prudent, nor even responsible, to pay out a dividend if you know for sure you have to borrow for it.”
Oil majors had no problem borrowing to pay shareholders during previous downturns. Over the years, Shell has weathered recessions, wars, nationalizations, and deep price slumps.
So why is this time different?
The coronavirus pandemic has delivered an unprecedented hit to demand through global lockdowns and it’s hard to say if it will ever return to 2019 levels. Shell doesn’t expect a recovery in consumption or oil prices in the medium term, the 62-year-old Dutchman said in a Bloomberg TV interview.
“I think a crisis like this has the potential to catalyze society into a different way of thinking,” van Beurden said.
It is a view that was shared by his BP Plc counterpart, Bernard Looney, earlier this week. As business travel is replaced by video conferences and employees work remotely, some shifts in behaviour may stick for longer, Looney said.
The long-term trends in energy consumption that determine company’s financial decisions -- such as air travel -- may change permanently and put many other oil majors’ dividends in doubt.
“Shell’s cut will also put pressure on other majors to revisit distributions,” Redburn said in a note. BP’s decision earlier this week to ride out the downturn with the usual spending cuts and debt increases “now risks being cast in an imprudent light.”
Shell can’t put all the blame on the virus. While van Beurden said the dividend cut was an unavoidable decision due to an unforeseen pandemic, his critics have long warned that the company had been over leveraged since its 2016 acquisition of BG Group, a big natural gas producer. The board approved a $25 billion share buy back in July 2018 that further strained the company’s balance sheet.
“The problems have been building for a while,” said Alastair Syme, oil analyst at Citigroup. “All roads lead back to the high price paid for BG and the burden that this acquisition put on the company’s financial structure.”
BP’s ratio of net debt to equity is even higher than Shell’s. Looney said this week that the company’s board would review the payout on a quarterly basis, potentially opening the door for a cut later this year. Exxon Mobil Corp. has just frozen its dividend for the first time in 13 years as its financial underpinnings feel the strain of the downturn.
Shell’s CEO said again and again on Thursday what a tough decision it was to cut the dividend, but it could make sense in the longer term.
European oil majors have promised to slash their carbon emissions over the next 30 years, requiring big increases in spending on renewables. Even before the pandemic, many analysts and shareholders were questioning whether Shell and BP could maintain their generous payouts, while also investing enough in both their core oil and gas businesses and clean energy.
The dividend cut gives Shell “the ability to allocate incremental capital to high-value barrels as demand recovers and accelerate its energy transition agenda to net zero carbon by 2050,” said Christyan Malek, head of oil and gas research at JP Morgan.
Shell made no promises about how it will spend the $10 billion a year removed from the dividend. Van Beurden said he would update the market on plans in the second half of the year.
“We will have to see what the response of our investors is going to be” to those plans, Van Beurden said.
Their verdict on Thursday, as shares dropped 11% in London, was clear: Sell.
— With assistance by Javier Blas
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