Oil companies and their beneficiaries that suffer from low oil prices are being rescued by the current ECB monetary policies. Negative interest rates and the ECB cooperate bond purchase program is turning corporate finances upside down and makes dividend payments rational even if revenue does not justify it. While the oil price is still low, there is no reason to believe that oil prices will stay at this level. There is a lack of investment in new production and world demand is increasing. Energy Information Administration (EIA) expects demand to outpace supply in 20171)US EIA raises forecast to world oil demand in 2016 and 2017 Source Nasdaq. The exact moment of a sharp price increase is hard to predict, but it will be somewhere between now and 2020. Oil companies and oil-producing countries have to weather the storm to survive.
The revenue of large oil companies such as Royal Dutch Shell and Exxon is comparable to the GDP of such countries as Poland or Belgium. As we argued in our periodical, investors should see such companies as “mini-states”. These companies have a history of a generous dividend payout.
Investors with a 3% stake or more in a company have to be registered in Europe. But even a fraction of 2.9% ownership in these companies generates a generous cash payout. “Capital World Investors” has a 2.9% stake in Shell that brings in an 87 million annual dividend payout. It is said that the Dutch Royal family is one of the biggest single shareholders in Royal Dutch Shell. In 2004 the family’s spokesman said its stake was “not more than 5%”2)Fortuin van Oranje en Nassau Source De Huizen van Oranje en Nassau. But if we assume their part is reduced to 2.9%, then the Shell dividend is still a substantial part of their income; they receive an estimated annual dividend income of more than 87 million euros. If Shell suspends dividend pay-out to its shareholders, it will have a devastating effect on the revenue of these wealthy and influential investors.
Shell, the Dutch-Anglo-Saxon company, is not making enough money to pay dividends3)Royal Dutch Shell plc second quarter 2016 interim dividend Source Shell from its earnings4)Earnings Per Share Summary Source Nasdaq like Russian oil companies which have access to cheap oil and profit from a depreciation of the ruble. The Russian oil company Lukoil pays a dividend covered by its earnings. Shell has to borrow money to fulfill its dividend obligation. Suspending the dividend for the next two years seems a rational decision for this company; however, this may not be acceptable to the nobility and rich of this world.
In a normal market situation, borrowing money to pay shareholders is a dead end road and comes close to a Ponzi-scheme. If debt increases, interest cost increases and a substantial part of the revenue has to be allocated to “debt servicing”. If a company revenue does not keep pace with the growth in the cost of borrowing, the organisation will arrive at a point where it is no longer able to fulfill its obligations towards its creditors. Such a company is not able to lend more as creditors are afraid they will lose their money, and as a result it goes bankrupt or has to increase its capital by issuing more shares. In either case, the stock price will fall sharply, and shareholders are the big losers. We have seen this many times in history.
If corporations can borrow against negative rates, there is a whole new dynamics not covered by the modern standard textbooks of economics. Negative yielding loans do not only increase the amount of debt it also increase a company’s revenue. Increasing the total amount of debt does not jeopardize the company’s ability to fulfill its obligation: rather the opposite is true. Issuing more debt can solve a cash problem, and it improves revenue. Thanks to the European Central Bank’s monetary policy, Shell can borrow money at a negative rate5)Negative Yields Seep Into Shell, Siemens Debt on ECB Distortions Source Bloomberg. The oil company can borrow money and service its debt as it pleases whatever its profit is. Increasing debt means increasing profitability and a better ability to “service the debt”. It sounds idiotic but that is how it is.
It is no surprise that Shell, as many other oil companies, raised their cash position by issuing more debt. With this pile of free borrowed cash, the company can pay a dividend the coming year even without earning a single dollar from its core activities. The ECB corporate bonds program and its negative yield policy makes large private enterprises part of the sovereign money creation process. Without the ECB program, Shell is not able to fulfill its dividend “obligation”. Shell’s dividend program is a handout to its investors, monetized by the ECB.
Investors should not only look to standard measures as debt-equity ratios and earning per share, but they should also look to the free-money per share. As long as the ECB free money policy is in place, oil price does not have to rebound for Shell to pay a 6.5% dividend.
References [ + ]
|1.||↑||US EIA raises forecast to world oil demand in 2016 and 2017 Source Nasdaq|
|2.||↑||Fortuin van Oranje en Nassau Source De Huizen van Oranje en Nassau|
|3.||↑||Royal Dutch Shell plc second quarter 2016 interim dividend Source Shell|
|4.||↑||Earnings Per Share Summary Source Nasdaq|
|5.||↑||Negative Yields Seep Into Shell, Siemens Debt on ECB Distortions Source Bloomberg|