April 29, 2019

Breakingviews: Cash is the real prize in oil-patch showdown

by Breakingviews.

Still convinced oil companies exist mainly to drill for oil? Think again. The battle for U.S. shale driller Anadarko Petroleum shows that the real driving force for producers these days is paying dividends. In this particular war, it means the company with less room to spend recklessly on closing a deal also has the greater pressure to do it.

Chevron and Occidental Petroleum are both offering cash and shares to buy the Texan oil firm, but start in very different places. In strict financial terms, Occidental can pay more. It thinks it can cut $3.5 billion of Anadarko’s annual spending, whereas Chevron eyes $2 billion. That explains how Occidental is offering $38 billion for Anadarko, compared with Chevron’s $33 billion. Anadarko is, for now, considering its options.

The problem for Occidental boss Vicki Hollub is that her counterpart Mike Wirth would find it easier to overpay. For one, Chevron is bigger. The company gushed more revenue in the first three months of the year than it’s offering for Anadarko. Its market capitalization of $225 billion dwarfs Occidental’s, which was around $50 billion before the bidding started. Chevron doesn’t need shareholders’ permission to bid; Occidental does.

Dividends cloud the picture, though. Oil investors are irrationally focused on payouts. Occidental has grown its generous annual dividend for the past 16 years and can keep paying even with oil as low as $40 a barrel, if production stays flat.

But that’s not enough for investors. Morgan Stanley’s analysis of oil stocks found that a major indicator of share-price outperformance was improving dividend coverage. On that score, Chevron is doing well – its free cash flow could fund its dividend almost twice over until 2021. Under Morgan Stanley’s base-case scenario, Occidental has to sell assets to cover its dividend costs.

That may explain why Occidental’s share price has languished relative to other oil majors. Its dividend yield of 5 percent is a shade higher than at Chevron and Exxon Mobil, which suggests investors feel the payout is less secure, despite the company’s protests to the contrary.

Of course, fixating on dividends in any industry is a recipe for disaster – just ask investors in General Electric, who got burned when a long-standing payout got cut. But for as long as that’s the way the oil patch rolls, Hollub has more reason than Wirth to keep fighting.

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