The Consequence Of Oil Prices On Dividend Stocks

 |  Includes: BNPUF, ERF, PEYUF, PGH
by: The Dividend Guy

Today, let's go back in time to when Canadian Oil Income Trusts were among investors' favorite picks. This was true not only for Canadians, but for Americans too. In fact, everybody benefited back then from the generous payout ratio doubled by extra tax exemptions for investors "who were there to encourage the oil sand industry".

I started investing in that period. This was a time where you could easily find an oil income trust paying a 10% dividend yield. In addition to a double digit dividend yield, you could also hope that your units would gain in value… and would come with an additional dividend increase! Back then, a 10% dividend yield wasn't a sign of a bad investment. It was only a sign that the oil industry was booming like there was no tomorrow. Remember, we all thought that the barrel would hit $200 in a few months.

Then, every company wanted to become an income trust. They saw the possibility to offer a high dividend yield through a tax efficient system. A few months later after both Bell and Telus tried to convert their companies into trusts, the Government shut the door and allowed only Canadian REITs to conserve this legal model. Therefore, all oil income trusts were turned back into regular companies, which paid a lot more taxes. We saw an important value drop in most oil income trusts upon the announcement. This was the end of the party. However, some companies managed to pay healthy dividends throughout the years, until this happened:

oil price1Click to enlarge

The price of oil sunk from almost $150/barrel to as low as $35/barrel within six months. The oil sand industry requires over $75 a barrel to generate sufficient profits. The extraction cost of oil from sands is very expensive and their business model cannot operate with low prices. Back then, several oil companies had to cut their dividends.

More Dividend Cuts to Come

With China's economy slowing down, combined with an obvious double dip recession in Europe, the price of crude oil is heading down once again. From a $100 plateau, we are now flirting with a $80 plateau.

OIL PRICE2Click to enlarge

These recent events have led to more bad news for oil producing companies' shareholders. Last week, one of the leaders of the industry, Enerplus (NYSE:ERF), cut its dividend by 50%. This announcement dragged the dividend yield to 8.3%. I guess you could have seen this coming when the stocks were paying over 15% in dividend yield! Now, Pengrowth (NYSE:PGH), Pennwest, Peyto Exploration & Development (OTCPK:PEYUF) and Bonavista Energy (OTCPK:BNPUF) may follow ERF's move. The price of oil is putting their business at risk, once again.

What Should I Do if I Own ERF Shares?

I'm lucky as I don't own pure oil sand producers in my portfolio. Instead, I've opted for Husky (OTCPK:HUSKF) and Chevron (NYSE:CVX), since they are more diversified. I'm confident that both companies will keep their dividend as their dividend payout is much lower. If I was holding any other companies mentioned in this article, I would probably consider selling them, even if they haven't announced a dividend cut yet. As a dividend investor, you should not gamble on possible dividend cuts. Since dividend growth is at the center of your strategy, you should concentrate on dividend growth, not hoping that a company won't cut its dividend and that they will get better over time.

This mentality exceeds the simple purpose of receiving a dividend. I think that the most important consideration when you select a dividend stock is to inquire about its potential dividend growth. In the oil sand industry, the dividend growth potential is linked to one thing; the price of a barrel. Since the oil price is highly unpredictable, I would avoid this type of investment. Remember that if the tension in the eurozone calms down and China's low interest rates stimulate the economy, the barrel might jump back to $100 in a few weeks. Therefore, it's almost impossible to know where we are going with oil. Do you really want this risk in your dividend portfolio?

Disclosure: I own shares of Telus, Husky Energy and Chevron.