Despite geopolitical tensions, the price of oil is falling. Indeed, the price of Brent crude, the international oil benchmark, has recently slipped below the $103 per barrel mark after hitting a high of more than $115 per barrel during June.
This is bad news for Royal Dutch Shell (LSE: RDSB) and BP (LSE: BP).
Falling profits
As two of the world’s largest oil companies, the price of oil significantly affects the profits of Shell and BP. However, the falling price of oil is not necessarily a reason to sell up.
You see, Shell and BP are used to a volatile oil price, as a result, both companies have built businesses that do not rely on a high price of oil to remain profitable. For example, the two oil majors are highly active within the refining and oil trading markets. What’s more, BP and Shell are currently going through a period of change.
In particular, both BP and Shell are currently in the process of streamlining their operations to reduce costs, divesting non-core businesses to improve returns on investment.
Improving returns
Shell is making great progress with its asset-disposal plan. Actually, many analysts have praised the company’s progress, which has put the group on a course to become one of world’s most profitable oil majors — on a free cash flow basis after the payment of dividends.
Indeed, Shell has already sold $8bn worth of underperforming assets so far this year and there are more sales to come. That being said, the group continues to struggle within North America, where Shell has found it hard to compete with local producers.
Additionally, BP has set a target of $10bn in divestments by 2015, the cash raised from these sales is earmarked for shareholder returns. So, as BP and Shell shrink to grow, the two companies should only be able to improve investor returns.
Having said all of the above, BP and Shell are not totally immune to a falling oil price and profits are likely to fall in conjunction with the price of oil. Nevertheless, the two companies do have several new oil wells coming onstream over the next few months, which should allow them to offset falling prices with higher output.
Here to stay
But BP and Shell are no longer growth shares. Indeed, growth has slowed over the past few years the two companies have become best known for their hefty dividend payouts. These dividend payouts are here to stay, even if the price of oil falls further.
Specifically, Shell’s current dividend yield of 4.3% is now covered one-and-a-half times by earnings per share. Meanwhile, BP’s dividend yield of 4.8% is covered twice by earnings per share, giving plenty of room for manoeuvre.
With these market-beating payouts, it’s easier just to sit back and let the dividends roll in rather than trying to second guess the market.
That’s why the best investors build a portfolio of reliable dividend paying stocks, just like Royal Dutch Shell, which has a dividend history stretching back to the Second World War.
