For income investors, the energy sector has a lot to offer. Some of the industry members offer dividend yields in the neighborhood of 10%; others distribute amazingly stable dividends in spite of the notorious cyclicality of their industry. Above all, equities of companies from the petroleum industry, as part of the natural resources sector, offer inflation protection and diversification, because oil stocks often do not move in sync with the general market (Fig. 1). As Jeremy Grantham said:
We believe the case for investing in resource equities is compelling. Historically, investors in resource equities have enjoyed strong returns, along with diversification and inflation protection benefits. Investors in resource equities also gain exposure to global growth and potential commodity price appreciation.
Last, but not least, the ongoing oil crisis has decimated stock prices of companies across the entire energy sector. For example, in the three years between June 2014 and May 2017, the SPDR S&P Oil & Gas Exploration & Production ETF (XOP), has dropped by as much as 57% (Fig. 1). This may present a once-in-a-decade opportunity for income investors to make entry at low price points.
Fig. 1. A comparison of XOP, an ETF, and the S&P 500 index, dividends back-adjusted, modified after barchart.com.
However, the challenge lies in picking proper investment targets from the hundreds of members of this huge industry. As of 2016, there are approximately 2,300 public oil companies traded on stock exchanges all over the world (Rapier; see also note 1). In the U.S., there are a total of 323 companies in the energy industry listed in NYSE, NASDAQ or Amex (see nasdaq), while investsnips.com lists a total of 267. In this article, we intend to narrow the potential candidates down to no more than a dozen, by following objective criteria which we hope can help identify companies that pay safe, high-yielding and growing dividends.
The oil patch
The petroleum industry is customarily subdivided into four groups, which are as follows:
- the oil and natural gas exploration and production: E&P, which include the integrated oil majors Exxon Mobil (XOM), Chevron (CVX), Shell (RDS.A; RDS.B), BP (BP), Total (TOT) and ENI (E), the so-called state oil companies Statoil (STO), PetroChina (PTR), Sinopec (SNP) and CNOOC (CEO), large independents such as Occidental Petroleum (OXY) or Apache (APA), and minor oil companies, e.g., Denbury Resources (DNR) and GeoPark (GPRK).
- Oil service firms, which provide products and services to the E&P companies, including the big three Schlumberger (SLB), Halliburton (HAL) and Baker Hughes (BHI) and numerous smaller ones such as Nabors Industries (NBR).
- The midstream group, which carries out transportation (by pipeline, rail, barge, oil tanker or truck), storage, and wholesale marketing of crude or refined petroleum products. Members in this group include, e.g., Kinder Morgan (KMI) and Energy Transfer Partners (ETP).
- The downstream group, which refines crude oil, process and purify raw natural gas, as well as market and distribute crude oil and natural gas derivatives. Examples in this group include, e.g., Valero (VLO), Marathon Petroleum (MPC) and Phillips 66 (PSX).
By screening for oil companies which have market capitalization no less than $10 billion and which pay dividends, we came up with an initial list of 40 companies, which cover all four above-mentioned groups (Table 1). When these companies are plotted into a scatter diagram, they appear to fall into two partly overlapping clusters (Fig. 2). The mid and downstream companies pay generally high, but still a wide range of, dividends, yielding anywhere from 2.41% to 9.14%. The E&P players, along with oil service firms, generally pay lower yielding dividends, but they seem to exhibit a range of market capitalizations, perhaps as a result of their more scalable business model.
Table 1. The initial list of dividend-distributing oil companies, based on author's compilation of data gathered from yahoo! finance and Seeking Alpha. s, oil service firm; m, midstream; d, downstream. For RDS.A and RDS.B, see note 1.
Fig. 2. Market cap versus forward dividend yield for selected oil companies with more than $10 billion market cap. Author's own chart.
Among these companies, there are only a few that did not reduce dividends during the hard times over the last few years (Fig. 3), while in the meantime many had to cut dividends as crashed oil prices led to weak cash flows (Fig. 4). The nine E&P companies that have either maintained or raised dividends are indeed some of the strongest businesses in the world, not only in the energy sector, but also beyond the petroleum industry. Five of them, namely, Chevron, Shell, Exxon Mobil, Occidental and BP, currently distribute dividends at over 2% yields. Oxy is especially noteworthy, because it is the only non-major that has made it to the top five list.
Among the dividend cutters, a few deserve special mentioning. The Chinese state oil companies, namely, PetroChina, Sinopec and CNOOC, used to pay high dividend yields prior to the oil crash. A more impressive record was kept by Total which had been keeping or raising dividends since 1982 (see Total), but the French super major had to cut dividends beginning 2015, which speaks volume about the severity of the current oil crisis.
Fig. 3. Dividends paid in US$, except for Suncor and Canadian National Resources which are in C$. Author's chart based on data from Morningstar.
Fig. 4. Dividends paid in US$, except for Imperial Oil which is in C$. Author's chart based on data from Morningstar.
Another French company Schlumberger stands out among the oil service firms, which is hardly surprising to the long-time followers of the oil service sector who know that Schlumberger is the undisputed industry leader in the oil service realm (Fig. 5). On the other hand, the downstream companies, except for the South Africa-based integrated conglomerate Sasol (SSL), have raised dividends aggressively since 2014; they could afford to do so because the downstream is counter-cyclical relative to the upstream (Fig. 6).
The midstream companies are normally counted on by income investors to pay stable and, because of their being structured as MLP, high-yield dividends. The vast majority of the midstream companies managed to avoid dividend cuts over the last few years, except for Kinder Morgan and Plains All American Pipeline L.P. (PAA) (see Fig. 7). Midstream companies are well covered by Seeking Alpha contributors. Clark compared ETP with Enbridge (ENB), concluding that "if you are looking for current income and the potential for capital appreciation, ETP is the one for you without question. If you have a long-term time horizon and are looking for dividend growth, ENB may be the better choice. But for my money, I am choosing ETP." Several contributors cautioned against Plains All American Pipeline. Fitzsimmons likes the outlook of Spectra Energy Partners (SEP), while others like MPLX LP (MPLX).
On the basis of the historical review of dividend distribution and previous studies, we were able to reduce the 40-company list to a short list of 13 companies, with the E&P players requiring further research (Table 2).
Fig. 5. Dividends paid in US$ for oil service firms. Author's chart based on data from Morningstar.
Fig. 6. Dividends paid in US$ for downstream companies. Author's chart based on data from Morningstar.
Fig. 7. Midstream company dividends paid in US$, except for Pembina Pipeline, Enbridge, TransCanada, which are in C$. Author's chart based on data from Morningstar.
Table 2. A preliminary list of companies for dividend income.
Dividend safety and growth
In order to further analyze the safety and growth potential of dividends for these short-listed E&P companies, we examine the following parameters:
- Proven reserves per thousand dollars of stock investment, which can be considered a proxy measure of how much assets buys with his stock investment;
- Annual production per thousand dollars of stock investment, which measures business output without the distortion effect of gyrating oil prices;
- Average life of bought proven reserves;
- Growth prospect with regard to reserves and production.
With $1,000, an investor can buy between 51.5 and 149.1 boe of proven reserves which will last from 8.1 to 14.8 years at the year-end 2016 level of daily production (Table 3). Reserves of CNOOC is worrisome, considering that they have an average life of merely 8.1 years; one should not be confused by its high 1P reserves per $1,000 of stock investment: its assets have gotten not much else beyond oil and gas reserves, as opposed to the other five which all possess considerable amount of mid and downstream properties, which do not show up in the hydrocarbon reserves. Oxy is the sole member that is anticipated to post substantial growth in reserves and production, which should compensates its low readings in reserves and reserve life per $1,000 of stock investment. Based on the above observations, we are inclined to forgo CNOOC, Shell and Chevron and favor BP, Oxy and Exxon Mobil.
Table 3. A comparison of short-listed E&P companies in terms of reserves and production purchasable with $1,000 of stock investment. *, as of May 26, 2017; **, average life of reserves bought with $1,000 of equity investment. Author's calculation based on company filings.
What would an income investor demand in his chosen investment target? We think that he wants a large enough income that is safe and hopefully grows over time. However, depending upon personal circumstances, some people may favor stable yield, while others go for dividend growth. Fortunately, they can construct a personalized portfolio by adjusting the proportion of components according to their needs.
A sample portfolio of dividend-paying oil companies is given in Table 4 below. In aggregate, these ten companies yield an average of 5.22%; their growth measured in various CAGR rates is anywhere between a poultry 4% as in BP to as high as 14.36% in Exxon.
We intend to regularly monitor the evolving fundamentals of these businesses; depending on deterioration or improvement of their business outlook, we may remove or add new names to the list.
Table 4. A selection of income-generating companies from the energy sector. *, nasdaq.com; **, Sunoco Logistics February 2017 presentation; ***, company guidance.
Those who are seeking secure and growing dividend income may want to have a serious look at the energy sector. By studying companies in the sector with regard to their dividend distribution history, and by examining the safety and growth prospect of the dividends, we were able to create a list of 10 companies that seem to satisfy the criteria of dividend safety and growth prospect.
Of these ten companies, three are E&P companies, one is a oil service firm, four are midstream players and two are downstream concerns. The current version of the list is up to date as of late May 2017. Going forward, we are going to regularly update subscribing members of The Upstream Oil Hub of changes in the composition of the portfolio.
Note: Although Royal Dutch Shell is incorporated in England and Wales, but is a tax resident of the Netherlands. The Class A shares (RDS.A) are required to pay a 15% Dutch tax on dividends, while the Class B shares (RDS.B) come with a dividend access mechanism, which does not require the withholding of a 15% Dutch tax on dividends.
Disclaimer: The author is not a registered financial advisor and does not purport to provide investment advice regarding decisions to buy, sell or hold any security. Before making any decision to buy, sell or hold any security mentioned in this article, investors should consult with their financial adviser. The author has relied upon publicly available information gathered from sources, which are believed to be reliable. However, while the author believes these sources to be reliable, the author provides no guarantee either expressly or implied. The author may choose to transact in securities of one or more companies mentioned within this service within the next 72 hours.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in OXY over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.