Today, let’s go back in time. Let’s go back to when Canadian Oil Income Trusts were among investor’s favorite picks. It was not only for Canadians but for Americans too. In fact, everybody benefited back then from the generous payout ratio doubled by extra tax exemptions for investors “who were there to encourage the oil sand industry”.

 

I started investing in that period. This was a time where you could easily find an oil income trust paying a 10% dividend yield. In addition to a double digit dividend yield, you could also hope that your units would gain in value… and would come with additional dividend increase! Back then, a 10% dividend yield wasn’t a sign of a bad investment. It was only a sign that the oil industry was booming like there were no tomorrow. Remember, we all thought that the barrel would hit $200 in a few months.

 

Then, every company wanted to become an income trust. They saw the possibility to offer a high dividend yield through a tax efficient system. A few months later after both Bell (BCE) and Telus (T) tried to convert their companies into trusts, the Government shut the door and allowed only Canadian REITs to conserve this legal model. Therefore, all oil income trusts were turned back into regular companies… paying a lot more taxes. We saw an important value drop in most oil income trusts upon the announcement. This was the end of the party. However, some companies managed their way to pay healthy dividends throughout the years. This was until this happened:

 

oil price1

 

The price of oil sunk from almost $150/barrel to as low as $35/barrel within six months. The oil sand industry requires over $75 a barrel to generate sufficient profits. The extraction cost of oil from sands is very expensive and their business model cannot operate with low prices. Back then, several oil companies had to cut their dividends.

 

More Dividend Cuts to Come

 

WithChina’s economy slowing down combined by an obvious double dip recession inEurope, the price of crude oil is heading down once again. From a $100 plateau, we are now flirting with a $80 plateau!

 

OIL PRICE2

 

These recent events have lead to more bad news for oil producing companies’ shareholders. Last week, one of the leaders of the industry; Enerplus (ERF) cuts its dividend by 50%. This announcement dragged the dividend yield to 8.3%. I guess you could have seen this coming when the stocks were paying over 15% in dividend yield! Now, Pengrowth, Pennwest, Peyto Exploration & Development (PEY) and Bonavista Energy (BNP) may follow ERF move. The oil price is putting their business at risk, once again.

 

What Should I Do if I Own ERF Shares?

 

I’m lucky as I don’t own pure oil sand producers in my portfolio. Instead, I’ve opted for Husky (HSE) and Chevron (CVX) since they are more diversified. I’m confident that both companies will keep their dividend as their dividend payout is much lower. If I was holding any other companies mentioned in this article, I would probably consider selling them even if they haven’t announced a dividend cut yet. As a dividend investor, you should not gamble on possible dividend cuts. Since dividend growth is at the center of your strategy, you should concentrate on dividend growth, not hoping that a company won’t cut its dividend and that they will get better over time.

 

This mentality exceeds the simple purpose of receiving a dividend. I think that the most important consideration when you select a dividend stock is to inquire about its potential dividend growth. In the oil sand industry, the dividend growth potential is linked to one thing; the price of a barrel. Since the oil price is highly unpredictable, I would avoid this type of investment. Remember that if the tension in the Euro zone is calming andChina’s low interest rates stimulate the economy, the barrel might jump back to $100 in a few weeks! Therefore, it’s almost impossible to know where we are going with oil. Do you really want this risk in your dividend portfolio?

 

 

Disclaimer: I own shares of Telus (T), Husky Energy (HSE) and Chevron (CVX).

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6 Comments   |  

6 Comments

Michel
June 18, 2012, 7:15 am

Good exposé Mike, but I wonder what you think of companies like IPL or Crescent Point Energy (which I’ve held for 4 and 5 years)? Are they at risk also?

June 18, 2012, 10:30 am

I gotta start paying closer attention. I own ERF, but your post is how I learned of the dividend cut. Disappointing! but as you say, not surprising given the payout.

Long term, I still like the oil sands producers, but I hear you on the $75 oil price. A global slowdown may well drive prices far below that threshold.

Mike
June 18, 2012, 12:44 pm

@ Michel,
I’ll take a look at both and get back to you :-)

@ Kurt,
the key is to get strong companies that can survive with their current cash flow (thinking of HSE and Canadian Oil Sand for example). it’s going to be a rocky year but we can’t operate without oil ;-)

Marie Lewis
June 19, 2012, 10:06 am

Nice content. I was thinking of buying an ERF share in the coming month and have already been through a lot of research for it, but thanks to you who made me get a distinctive picture with a brief analysis. It’s really going to help me out all the way.
Marie

August 8, 2012, 6:39 am

[…] to have Canadian Oil Income Trusts paying 8-9% with steady monthly distribution (anybody still hold ERF?). If you are still looking for high dividend paying stocks, you are heading towards the high […]

June 23, 2013, 4:35 pm

[…] to have Canadian Oil Income Trusts paying 8-9% with steady monthly distribution (anybody still hold ERF?). If you are still looking for high dividend paying stocks, you are heading towards the high […]

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