Energy has, until a few days ago, been one of the hardest hit sectors in this market collapse. Oil and gas stocks were already being hit before this all began on fears about global growth. Then, just as it was becoming clear that those fears were about to come true as the world’s economy was being shut down in response to the virus, the OPEC+ deal to cut production and support oil prices fell apart.
It was a perfect storm for oil stocks, so it wasn’t surprising that as the S&P 500 lost around a third, energy led the way with the sector ETF (XLE) dropping by well over fifty percent. Over the last few days, however, there have been some signs of life in energy or, more specifically, in big oil.
The small, heavily leveraged companies still have massive problems. The big drop in prices and the collapse of global demand, even if it is temporary, will hurt them, but that isn’t their only issue. Many of them carry a heavy debt load, and their loans are secured by oil reserves that are now worth around sixty-two percent less than they were at the start of the year. That raises very real fears about solvency in some cases, so until things settle down, small E&P stocks are just too risky for most investors.
The big boys however, the multinational, integrated firms, feel that pain less. This is a rare case where size actually increases flexibility. It means that the cash reserves are larger in most cases, and when addressing a pullback, there is more fat to cut. Still, cutbacks are inevitable in some form, and there has been a significant rally in big oil stocks over the last few days as their priorities in that regard have become known.
Up until this morning, that rally has been somewhat selective, even among that fairly select group, with the big European companies such as Royal Dutch Shell (RDS-A) and BP (BP) leading the way. (In the interests of full disclosure, I should say that I bought some RDS-A on Wednesday and am still long the stock)
They started to gain on Thursday of last week. As crude bounced off of the twenty-dollar level and oil prices began to stabilize a bit, at least for now, investors started to look at the fifteen or sixteen percent dividend yields available from those stocks. Conventional wisdom was that those payouts were vulnerable, but at those levels, even a fifty percent cut in the dividend, which would be an almost unprecedented move) would leave you with around an eight percent yield in a market where the 10-Year was paying well under one percent.
There is always demand for yield in the world, so even that looked pretty attractive, but then the companies themselves began to suggest that they may not even cut their dividends, or at least not for some time. Shell was the first, revealing plans over the weekend to slash operating costs and suspend their stock buybacks in order to maintain cash flow. And for big oil, cash flow means dividends.
That is why the one-week chart for RDS.A looks like this, with a forty percent bounce since Wednesday’s lows:
This morning, Chevron (CVX) told a similar story when they announced plans to slash spending and buybacks and said that protecting their dividend was a priority. The yield there is “only” eight percent, but as I said, in the current environment that qualifies as “juicy.”
Normally when a market is flying around, big, sudden jumps up don’t signify that the chaos is over. They are just another sign of continued volatility. This case, though, is a bit different. Big oil stocks had the “advantage” of having a lot of the demand problems priced in. The U.S. stock market may have flown to giddy heights over the last few years, but energy stocks have been sounding a warning for some time.
So, once the collapse of oil slowed and with bad news already discounted, the big dividend yields available from big oil stocks became very attractive. As they begin to reveal plans to protect those dividends, their appeal is increasing on a relative basis. The likes of RDS-A., BP, and CVX may continue to outperform for a while.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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