Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

This past week brought together a display of the rapidly changing fortunes of oil markets. In a world focused on the prospect of economies reopening following the rollout of vaccines, Brent Crude scaled its highest levels in over a year close to US$60 per barrel1.

Supply factors helped too. OPEC confirmed that compliance among its member countries with previous production cuts was in excess of 100% in December, and an additional, two-month voluntary cut by Saudi Arabia took effect from 1 February2. Data out this week showed US oil stockpiles falling significantly last month3.

The days of negative oil prices in West Texas last April now seem a very distant memory, but we were reminded this week of how the oil industry is still struggling to escape the clutches of the current crisis through the quarterly results of some of the world’s largest producers.

Despite a rising oil price, however, underlying profits at BP and Shell’s net income fell to just fractions of their year-ago levels in the final quarter of last year4. News of a quarterly loss at Chevron and write downs amounting to US$19 billion at Exxon Mobil capped off a disappointing week5.

Higher oil prices were only one part of the equation in the final quarter of last year, with falling fuel sales and refining margins the defining factor. Importantly for investors, many of whom look to BP and Shell as reliable sources of income, operating cash flows – an indicator of the sustainability of dividend payments – remained weak.

Large companies like BP and Shell have the borrowing power to sustain dividend payouts not covered by earnings over short periods, but pressures have been mounting. Both companies took what, for them, were extraordinary steps last year by cutting their dividends – by two thirds in Shell’s case and by about a half at BP.

There was though a chink of light from Shell this week, as the company said it would lift its dollar dividend this quarter by about 4%. There was no comparable statement from BP.

There are good reasons to believe that oil market conditions will stay much healthier this year than in 2020. America’s shale energy fields continue to pose a threat, in that their wells can be opened or capped fairly quickly and at relatively low cost. That makes it easier for US producers to capitalise on rising prices by lifting production for a while, thereby depressing prices again.

However, shale producers have been under pressure over the past year to prioritise investor returns and hold back production when prices rise. America’s oil production fell by an estimated one million barrels per day last year6.

Meanwhile, President Biden has already signalled a less amenable stance to the sector than his predecessor, by cancelling a permit to build a major pipeline from Alberta to Nebraska7.

Against that, no-one much knows how fast the take-up of electric vehicles will be after the current crisis, or how far governments are actually prepared to go to achieve their greenhouse gas reduction targets by switching to new sources of renewable power.

Certainly, the challenge from renewables continues to build. BP and Shell have already taken significant steps to hedge their bets and further moves will surely follow – to their cost over the short term.

Much improved oil prices and the reopening of economies later this year should start to relieve the pressure on oil majors quite quickly. BP and Shell still offer attractive dividend yields of around 6% and 4% respectively along with an exposure to a recovering oil price and demand improvements8.

However, the reputations of BP and Shell as exemplary sustainers and growers of dividends that investors could always rely on have undoubtedly been marred by this crisis. While oil companies were certainly not alone in cutting dividends in 2020, conditions over the past year have laid bare the risks inherent in having a policy of paying dividends not completely covered by earnings come what may.

Investors seeking a more diverse exposure to income bearing investments will find a number of ideas on Fidelity’s Select 50 list of favourite funds.

The Franklin UK Equity Income Fund has a bias towards large UK companies and offers a balance between stocks with a dividend yield at a sustainable premium to the stock market as a whole and stocks growing their dividends at a faster than average rate. Current large holdings include Unilever, Royal Dutch Shell, Rio Tinto, AstraZeneca and GlaxoSmithKline and the Fund currently yields about 4%, though this is not guaranteed9.

The FP Foresight UK Infrastructure Income Fund focuses on UK investment companies that own renewable energy and other infrastructure assets. The fund is diversified across a range of renewable technologies, including wind power and solar photovoltaics, and aims to achieve a 5% annual income from its investments, though this is also not guaranteed.

Five year performance

(%)
As at 31 Jan
2016-2017 2017-2018 2018-2019 2019-2020 2020-2021
Brent Crude 60.5 24.1 -10.4 -6.0 -4.0

Past performance is not a reliable indicator of future returns

Source: Refinitiv, returns in US dollar terms as at 31.01.21

Source:

1 Bloomberg, 04.02.21
2 OPEC, 03.02.21
3 EIA, 03.02.21
4 BP, 03.02.21 and Royal Dutch Shell, 04.02.21
5 Chevron, 29.01.21, and ExxonMobil, 02.02.21
6 EIA 12.01.21
7 Reuters, 20.01.21
8 Bloomberg, 04.02.21
9 Franklin Templeton, 31.12.21

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Overseas investments will be affected by movements in currency exchange rates. Select 50 is not a personal recommendation to buy or sell a fund. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

Topics covered:

Active investing; Investing for income; SharesVolatility

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