28th May 2015
Brewin Dolphin equity analyst Iain Armstrong takes a look at the differing fortunes of the two FSTE 100 listed oil majors BP and Royal Dutch Shell…
We know that the dividend is a key priority for management at BP, but at what spot price do we estimate the dividend is actually at risk for BP? We said in January that BP’s dividend was safe at a$60 long term Brent price. Since then BP has said that it will attempt to run the company based on a long-term price of $50. However, it will take time for BP to set the company to the new strategy. Therefore, in the meantime, it would be vulnerable to oil prices around $50.
Given the higher level of operational gearing to crude prices at BP, are the earnings prospects here not better (vs Shell) in a more benign spot price environment, even when paired off against the external risks faced by BP (Rouble and Macondo legacy)?
There is not that much difference in the oil price gearing between the two companies and the bigger exposure to the Downstream, currently having a bit of a renaissance, at Shell narrows the gap further. Once BG is on board the gap will be even smaller. The different long term oil price assumptions used to run the two companies ($50 at BP, $70 at Shell, would make a difference).
Royal Dutch Shell
What is the time frame to the deal? There has been no change to the original guidance of one year. Are there any barriers to its completion? There are several regulatory hurdles to cross. The most important being in Kazakhstan, Brazil and China. However, unlike the proposed Syngenta / Monsanto deal, we do not think that the deal requires disposals to pass the regulatory hurdles.
How do the economics of this deal stack up at different oil prices? Shell said that the deal would make economic sense at a long-term average Brent price of around $80 per barrel based on the assumptions of synergies and capex cuts. While this is clearly above the futures price in 2016/17, we have argued that Shell has understated the potential benefits of the deal.
What impact does the oil price have on the sustainability or growth of Shell’s dividend?
In January we argued that Shell would still be able to pay its dividend at a long term oil price of $60 per barrel. Since then it has significantly reduced its capex assumptions, as has BG Group. The additional gearing involved in the deal would stretch the balance sheet if the oil price remain around $50 per barrel but the improvement in cash flow from BG Group would mostly offset this concern. Clearly a $20 difference between Shell’s medium term oil price assumption would be a concern. However, we do not believe that the oil price would remain at $50 or below for an extended period.
Is there an oil price at which Shell’s dividend is at risk? $50 Brent for an extended period.
Given the difficulties BG have had with Offshore Brazil, what likelihood is there that RDSB will fare any better? Should we not be cynical about the ability of the RDSB to add value here? Offshore Brazil has been a phenomenal success story for BG. There have been problems with local content but in the bigger scheme this has not been a major concern. Petrobras is a concern but we note that it has been operating normally through the “carwash” scandal.
In conclusion, we think that the underperformance of RDSB versus BP is unjustified on fundamentals. We accept that there are risks from completing the BG acquisition, but there are also risks to BP from the conclusion of the Macondo trial later this year. In addition, we think that BP (and its dividend) is more vulnerable than RDSB to an extended period of lower oil prices given its need to rebuild production and reserves following the major overhaul of the company in response to the Macondo accident.