The oil market's downturn has not been kind to income investors. Lower oil prices have taken away the key fuel behind a number of generous dividends over the past year. However, it hasn't taken away all of the generous oil-fueled dividends, with ConocoPhillips (NYSE:COP) and Occidental Petroleum (NYSE:OXY) being among the handful of oil-related companies that still offer investors generous payouts. However, both dividends still could be at risk at some point in the future, because both oil producers are counting on the return of an oil price north of $60 a barrel to balance their cash flow with outflows. While neither dividend is in immediate danger, this is something investors need to watch over the next year.
Balancing the budget at a $60 oil price
Like most oil companies, Occidental Petroleum significantly pulled back on its oil and gas investments this year. After spending $8.7 billion last year, the company plans to spend 33% less, or $5.8 billion, on new investments in 2015. Further, it expects to end the year with a capital spending run rate of $4 billion. However, as significant as that reduction is, the company will still run a deficit at the current oil price because it needs $60-per-barrel oil to balance its cash flows with outflows for not only capex but aso its generous dividend:
This breeds a concern that if oil stays sub-$50 a barrel for the next few years, the company's generous dividend could be in trouble. However, that assumes a lot of things, such as the company's failure to capture additional cost savings above the $400 million in savings captured through the first half of this year. It also assumes that the company's Permian Resources segment won't improve its results any further after Occidental drove a 24% improvement in its well costs and a 40% decrease in the days it takes to drill and complete one well.
Further, it's worth noting that the company has a strong balance sheet, with an A-rating from the major rating agencies giving it a lot of financial flexibility. That balance sheet was recently boosted by the sale of its non-core Bakken shale position, which brought in $500 million. Additional asset sales could be pursued if the company needs to plug holes in its cash flow.
In other words, while Occidental Petroleum is currently gearing its business to run on a $60 oil price, its dividend isn't doomed if oil doesn't top that mark, because it has a number of levers to pull to balance cash inflows with outflows.
Banking on $60 oil by 2017
The same can be said about ConocoPhillips, because it, too, is gearing its business to run on a $60 oil price. The company shows that it expects cash flow to match capex spending and dividends in 2017 at a $60 oil price:
While that's a concern given the current sub-$50 oil price, the $8 billion number is half of what the company had been spending on capex before the downturn. Further, it's also a few billion less than the company's current $11 billion capex plan. Having said that, while $60 is the current breakeven number to generate the $8 billion in cash flow the company will need to run its business in 2017, there's the potential for that number to fall further. The big driver is additional cost reductions the company has the potential to capture if oil stays in its current range for a few more years. ConocoPhillips is already planning to reduce its operating costs by $1 billion while capturing $1 billion in capital cost deflation by 2016, while more downside pressure would be put on both if oil stays lower for longer.
Not only that, but ConocoPhillips, like Occidental, also boasts of a strong balance sheet, with an A-rating from the major credit rating agencies. Further, the company continues to trim its portfolio and monetize non-core assets to keep its balance sheet strong while it runs a cash-flow deficit. So it, too, has a lot of financial flexibility.
What this tells us that, again, while $60 is the number ConocoPhillips is gearing its budget toward, it's not etched in stone as the do-or-die number for the company's ability to maintain its dividend.
Given how everything stands right now, ConocoPhillips and Occidental Petroleum need a $60 oil price to match cash flow with capex plus dividends going forward. However, while that breakeven price is the number both are banking on, it doesn't mean these dividends are in danger if we don't see $60 oil. Both companies have a number of other levers to pull, including pushing more costs out of their business or selling assets to bridge the gap. In other words, while investors need to keep an eye on these companies should oil continue to remain stubbornly below $60 for more than a year, they don't need to necessarily worry that the dividends are in danger if oil doesn't recover to that level.