Oil prices have nosedived this year. Dual shocks to demand (from the slowdown in the global economy caused by the COVID-19 outbreak) and supply (from the collapse of OPEC's market support agreement) have pushed the price of crude oil down to its lowest level in decades. That's cutting deeply into the cash flow of oil producers, forcing them to slash spending.
The first thing they've cut is their capital expense budgets. However, a growing number of energy companies are also reducing their dividends to conserve cash. That trend is likely to continue as they focus on surviving this turbulent period in global history.
Finally reaching the breaking point
Up until recently, dividends had been on the upswing in the oil patch. Many companies had reset their businesses to run at lower oil prices by selling assets and cutting costs. Those moves enabled them to generate free cash flow as long as oil was around $50 a barrel. However, with crude prices crashing into the $20s, oil companies have had to adjust their plans to run on even lower pricing.
Occidental Petroleum (OXY -0.84%) was among the first oil companies to slash its dividend. The company reduced its payout by 86% one day after its yield spiked to an eye-popping 25%. That move abruptly ended a streak of 17 consecutive years of dividend increases for Occidental, which had grown its payout by more than 500% since 2002. However, it had no choice but to reduce its dividend following the significant deterioration in its financial profile as a result of its debt-fueled acquisition of Anadarko Petroleum last year.
Apache (APA -0.63%) also recently slashed its dividend, cutting it by 90% to preserve cash during these turbulent times. While Apache hadn't increased its dividend since 2014 -- right before the last oil price crash -- it was also one few that preserved its payout during that downturn. However, with $937 million of bonds maturing between now and January of 2023, Apache opted to retain the $340 million per year it would have paid out in dividends to help it address these upcoming maturities in case oil prices don't recover.
Midstream company Targa Resources (TRGP -1.35%) also recently announced a substantial dividend reduction. It's slashing its payout by 89% in a move that will save it about $755 million per year. Targa will use those savings to repay debt following a massive expansion program. Targa, like Apache, had managed to preserve its dividend through the last downturn. However, its financial metrics had been on very shaky ground until recently because it continued to pay out most of its cash to support its dividend even as it kept spending money to expand its midstream footprint.
More cuts are inevitable
More energy companies will likely announce dividend reductions in the coming weeks. One sub-sector where that seems almost certain is master limited partnerships (MLPs) that focus on gathering and processing oil and gas. CNX Midstream Partners (CNXM) has already stated that it's reevaluating its capital allocation opportunities. CNX Midstream could opt to slash its distribution -- which spiked to yield more than 30% in recent days -- and reallocate that cash toward debt reduction or buying back its units, which have cratered this year.
Another likely candidate for a payout reduction is Western Midstream Partners (WES 0.54%). Investors see it as a near certainty as its unit price has cratered, pushing its yield up near an eye-popping 70%. The MLP currently counts Occidental Petroleum as one of its main customers, which is concerning since the reduction in Occidental's activity level this year will likely result in fewer volumes flowing through Western Midstream's systems than it initially anticipated. That will affect the fees it collects, which is coming at an inopportune time for the company, given its already weak financial profile.
Several other MLPs are in similar situations where they risk declining volumes at a time that they have shaky financials. Many have already started making cuts by reducing their capital spending. Noble Midstream (NBLX), for example, cut its budget by 35% this year to reflect reduced activity levels by its customers. However, with an already elevated leverage level and a tight coverage ratio, Noble Midstream might also need to reduce its payout to shore up its financial situation. Investors see that as a near certainty, given the spike in its yield, which was over 70% at one point in the past week.
Income investors can't seem to catch a break
Dividends had just started making a comeback in the oil patch before crude prices collapsed this month. Now, they're crashing down as companies adjust so that they can survive. Most payouts probably won't ever again reach their previous heights because companies will probably put an even higher priority on balance sheet strength in the future. That will keep dividend payments low so that these companies don't ever find themselves in a situation where they'll need to cut them again should there be another crash.