One of the most interesting characteristics of many companies in the oil and gas sector is they pay variable dividends.
That makes them unlike the companies in many other industrial sectors of the U.S. economy. Because so many of these firms pay variable dividends, dividend payouts by firms in the oil and gas sector are especially sensitive to changes in their business conditions. Given the nature of the oil and gas sector's business, that means they are very sensitive to changes in the price of crude oil. That in turn makes the number of dividend reductions being recorded by these firms very useful for gauging the relative health of the entire oil and gas industry.
That's a big deal for investors, because as we're about to show, how the price of crude oil is trending has an impact on how many firms within the industrial sector adjust their dividends. In the case of firms that pay variable dividends, that adjustment happens automatically without any action by the firms' board of directors. The following chart presents the average monthly spot price of West Texas Intermediate crude oil along with the sampling of dividend reductions we've tracked since January 2015.
Throughout much of this period, domestically produced crude oil at $60 per barrel appears to be a significant threshold. When the price of crude oil rises above this level, the number of firms reducing their dividend payouts each month generally declines. When crude oil prices rise well above this level, the number of dividend reductions falls to very low levels.
We see an opposite pattern when the price of a barrel of crude oil drops below $60 per barrel. When that happens, we often see a rising number of firms whose dividend payouts decrease along with the decline in oil prices. The further the price falls below this threshold, the more the number of dividend reductions within the oil and gas sector increase. You can see that pattern in 2015 and early 2016, which marked a time of distress for these firms. You can especially see it during the coronavirus pandemic recession, which saw oil prices plunge below $20 per barrel.
Taking these patterns into account, the chart also reveals a potentially useful threshold to identify when dividend reductions are out of the ordinary. As a general rule of thumb, whenever the number of dividend decreases rises above ten per month, it generally coincides with some level of distress for the industry.
At the same time, we very rarely ever see the number of dividend reductions ever decline to zero. Since January 2015, that has only ever occurred once, in June 2021. This characteristic is attributable to the "noise" generated by variable dividend payers, where we recognize dividend decreases don't always signal a widespread level of distress, but are instead indicating typical month-to-month or quarter-to-quarter variations in an otherwise relatively healthy market for the industrial sector. As another general rule of thumb, we view anything between a range of zero and ten dividend decreases reported in any given month as typical for the oil and gas industry when its experiencing relatively good business conditions.
That brings us to May 2023, which saw 14 dividend reductions in the oil and gas sector while the average price of crude oil during the month was $71.58 per barrel. We should recognize that most of the historic data on the chart occurred when inflation was at historically low levels in the U.S. economy. Since March 2021, the nation has experienced much higher rates of inflation. That much higher inflation may have reset the dollar-per-barrel threshold that may be used to identify when the oil and gas industry is experiencing distress. Doing the inflation-adjustment math, the $60 per barrel "distress" threshold from March 2020 (during the coronavirus pandemic recession) is the equivalent of about $71 per barrel in terms of constant May 2023 U.S. dollars.
Since we have just one data point to suggest that threshold is significant, it will be interesting to follow this sector to see if that hypothesis holds.
U.S. Energy Information Administration. Cushing, OK WTI Spot Price (FOB) - Monthly. [Online Database]. Accessed 9 June 2023.
MarketBeat. Recent Dividend Cuts. [Online Database]. Accessed 29 May 2023.
Seeking Alpha. Dividend-Stocks News. [Online Database]. Accessed 29 May 2023.
Wall Street Journal. Dividend Declarations. [Online Database]. Accessed 29 May 2023.