The unthinkable happened on Thursday – Royal Dutch Shell (LSE: RDSB) cut its dividend, for the first time since World War II. But the share price still gained 4% in response. BP (LSE: BP) didn’t do so well on the day. BP shares fell 5%.
Through the previous oil price crash, BP’s CEO Bob Dudley promised to maintain the dividend. This time, under new boss Bernard Looney, we’ve had no similar commitment. The company did confirm its quarterly dividend on Wednesday, and that gave the shares a boost on the day. But it looks like the shock news from Shell might well have made BP shares a bit shaky today.
The oil price has recovered a little since its recent low, but Brent Crude is still fetching only around $25 per barrel. That’s obviously bad news for oil companies and their shareholders. And the longer the coronavirus pandemic goes on, the longer demand will remain low, and the more pain there’s likely to be.
Oil firms’ debt crisis
That’s why I think smaller oil companies with high debt could be in serious trouble this year. Premier Oil and Tullow Oil were both almost crippled by debt during the previous crunch, and both are under pressure again. So far in 2020, share prices for both are down more than 60%.
If you bought either right now, you might well have a multibagger on your hands should oil prices get back up to profitable levels in the next few months. But the downside, I think, is a significant risk that either of these could go bust. Or if they don’t go bust, they might need to raise new capital, diluting existing shareholders’ interests.
Shell and BP shares down
By comparison, BP shares are down 33% since the start of the year, with Shell shares are down 43%. Those are significantly smaller falls than those of Premier or Tullow. But the size of the falls surprise me, when I compare the the risks facing the two pairs of companies.
There’s no realistic chance that Shell or BP will crash to nothing. But the market doesn’t seem to be affording them much of a premium to cover their far superior safety positions. To me, that suggests BP and Shell shares are too cheap in relation to their actual risk. Or Premier and Tullow shares are still too expensive. Or both.
BP shares look set to pay a dividend above 10% this year. If that goes ahead, it will be a phenomenal cash return. But remember, there’s no Bob Dudley promise this time round.
Until the cut, Shell investors were look at a similar yield. But Shell has cut its first-quarter dividend by two thirds. If it maintains that level, we’d see a yield of around 3.5%.
I reckon the next 12 months could be a period of shakeout for the oil business, and I can see a number of firms not making it. But those that do should come out strong and ready to cash in when demand and oil prices rise again. I think this is a great time to buy Shell and BP shares cheap.
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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.