Over the past few weeks, the BP (LSE: BP) share price has plunged in value. After these declines, BP shares now support a dividend yield of 15%. That’s more than double the market average.
The big question is, can investors rely on this market-beating income stream, or should you be looking elsewhere for income?
Lower production costs
The oil giant has been hit by a double gut punch this year. First of all, the coronavirus outbreak has slammed demand for oil and petroleum products around the world.
And secondly, the decision by Saudi Arabia and the rest of OPEC to increase oil production at such a sensitive time has sent the price of black gold plunging to a multi-decade low.
The good news is that BP is, to some extent, already prepared for this market. When the oil price last crashed in 2014, the company undertook a massive restructuring program, cutting costs across the board.
These actions have positioned the company well for the current market. At the beginning of 2018, the business told investors that its average unit production cost was down 46% since 2013.
BP’s then head of upstream, Bernard Looney, claimed that the group’s global production costs had fallen from around $13 a barrel in 2013 to $7 for 2018.
The average cost of production varies from region to region. However, reports suggest that the company’s cost of production in the North Sea is less than $15 a barrel. That’s down from more than $30 in 2014.
These numbers imply that even with oil trading below $30 a barrel, BP is earning a profit on every barrel it produces. That said, these figures exclude other costs, such as exploration spending, maintenance and head office costs.
Still, the amounts show BP has the capacity to endure the current market environment.
BP shares on offer
At this stage, it is not very easy to say if BP can maintain its dividend at the current level. Nevertheless, the company has plenty of options. As noted above, production costs are low, which should help the firm continue to cover basic costs.
If the oil price downturn persists for an extended period, management will have to cut costs further. They will also need to reduce capital spending. In this scenario, the dividend could be for the chop, although before eliminating the payout entirely, BP might turn to a scrip alternative.
The company did this in the last oil price crash. Rather than paying investors in cash, it offered shares instead. These actions reduced pressure on the group’s balance sheet and cash flows.
When the market had settled down, the group resumed cash payouts.
It seems likely that it will use the scrip alternative this time around as well. The company might also cut the overall distribution. A 50% cut would still leave BP shares yielding 7.5%.
A combination of both will allow management to continue rewarding investors while keeping the balance sheet in order.
As such, it looks as if BP shares will remain attractive from an income perspective.
