Icahn Trap Snares Oil CEOs in Growth-Killing Dividend Addiction

Nov. 11 (Bloomberg) — Call it the Carl Icahn trap, the dilemma facing scores of oil executives forced by shrinking cash flows to choose between satisfying shareholders and maintaining investment in future projects.

Last week, Transocean Ltd., owner of the world’s largest fleet of offshore drilling rigs, was forced to batten down the hatches in the face of falling oil prices just six months after boosting its annual dividend in response to pressure from Icahn, the 78-year-old activist investor. In late October, BP Plc hiked payouts to holders even though its operating cash flow next year won’t be sufficient to cover the added expense, according to an analysis by Oppenheimer & Co.

James Kinnear knows the trap as well as anyone. Twenty-five years ago, as chief executive officer of Texaco Inc., he took on debt, sold assets and slashed exploration budgets as a fight with Icahn goaded the company into paying billions to investors. One of the industry’s fabled Seven Sisters that dominated global oil in the middle 20th century, the weakened Texaco disappeared into the arms of Chevron Corp. about a decade later.

“In the oil business, you have to take a long-term view if you’re going to be successful; 90-day results just don’t happen,” Kinnear said in an interview. “That’s one of the challenges with corporate activists. They have a different mindset.”

Icahn and a parade of fellow activists are exerting pressure again on an oil industry grappling with rapidly falling prices. Exploration companies have started raiding their drilling budgets to cover $120 billion in dividends expected by investors like the New York-based billionaire. That mountain of cash would be enough to drill about 800 deep-water oil wells.

$50 Billion Hit

Global crude prices have tumbled as much as 29 percent since late June, wiping out about $50 billion in cash flow for energy companies, according to researchers at Barclays Capital Inc. That’s forcing oil executives to find a way both to satisfy demands for hefty dividends while investing in high cost projects needed to maintain production levels.

Energy producers and equipment suppliers are reassuring shareholders that investor payouts are sacrosanct. First to go when companies look to plug the gap will be spending on equipment like drilling-rig leases and hard assets such as new floating platforms, Barclays said in a Nov. 6 note to clients.

‘Acutely Aware’

“We are acutely aware of the current environment,” Philip Rykhoek, chief executive officer at Plano, Texas-based oil producer Denbury Resources Inc., told analysts and investors on a conference call last week. In evaluating the company’s options, he said that “maintaining current dividends is probably one of the highest priorities.” Capital spending on new projects will be evaluated, “which of course affects production growth.”

The world’s 50 largest non-state energy companies are on pace to shell out $120 billion in dividends next year, according to an analysis by Wood Mackenzie Ltd., a global oil industry research firm. That dwarfs the $79 billion those companies are expected to spend on exploration, said Fraser McKay, a corporate upstream principal analyst based in Wood Mackenzie’s Houston office.

Investors would abandon many energy stocks without fat dividend payments, which ensure returns to shareholders even when falling oil and gas prices drag down share prices, said Pavel Molchanov, an analyst at Raymond James & Associates in Houston.

Oil company dividend cuts are “not going to happen,” Molchanov said. “It’s unheard of” for the largest energy companies, which didn’t lower dividends even when oil briefly fell to about $30 a barrel in 2009, he said.

Duty to Shareholders

Activist investors’ pressure to maintain dividends even in tough times can be a reminder of companies’ duty to their shareholders, said Kinnear, the former Texaco executive who holds no ill will for Icahn’s tactics.

“Not all activism is bad,” Kinnear said, referring to the late 1980’s battle chronicled in Daniel Yergin’s book The Quest. Activists “are kind of a necessary evil out there, and management has to be strong enough to meet the needs of all shareholders.”

Icahn didn’t immediately return a call or email seeking comment.

For an industry where “scale and technology matter,” reinvesting in operations is the better long-term strategy than returning cash to shareholders, said Gianna Bern, principal at energy consulting firm Brookshire Advisory & Research.

“Those who have spent money reinvesting are going to be the ones who survive in these types of downturns,” Bern said.

Raising Dividends

ConocoPhillips was the first major oil company to bite the bullet as the oil bear market entered its fifth month. The Houston-based company told investors on Oct. 30 that it will cut 2015 spending by as much as 5 percent as falling crude prices make some fields unprofitable to drill.

Chairman and Chief Executive Officer Ryan Lance has protected ConocoPhillips’s dividend from the collapse of crude markets. In July, when the current price slide was beginning to pick up steam, the company raised its annual payout to investors by 5.8 percent to $2.92.

Lance assured analysts during a conference call that spending curbs won’t interfere with the company’s plans to raise production by 5 percent a year, reversing a trend that’s seen output drop in six of the past seven years.

Icahn Pressure

In the case of BP, the oil giant is expected to generate operating cash flow of $27.7 billion next year, more than enough to fund $24.5 billion in estimated spending, according to the analysis by Oppenheimer & Co. The dividend will cost an added $5.8 billion, leaving the company $2.6 billion short. That will have to be made up through some combination of asset sales, digging into cash on hand and debt, Fadel Gheit, an Oppenheimer analyst, said Nov. 7 in a note to investors.

Transocean, the worst-performing energy stock in the S&P 500 this year, was one of the first oilfield gear suppliers to see contracts canceled or deferred when crude prices tumble.

Just six months ago the Swiss company boosted its annual dividend by 34 percent to $3 a share in response to pressure from Icahn, who demanded bigger payouts after taking a 5.9 percent stake in the company. Last week, Transocean wrote down the value of its drilling fleet by $2.76 billion as a worldwide glut of deep-water rigs deflated the company’s ability to generate cash amid the worst oil bear market this decade.

The company’s stock lost 42 percent of its value this year, on track for the worst annual performance since 2011, when Transocean was embroiled in legal and regulatory battles after the Deepwater Horizon blowout that killed 11 rig workers.

Cutting Capex

On Nov. 10 the rig company reduced its 2014 operating and maintenance cost estimate to $5.1 billion to $5.2 billion from a previous forecast that went as high as $5.3 billion. Spending will be even lower next year, Chief Financial Officer Esa Ikaeheimonen said during a conference call.

Transocean’s board will consider next spring whether any change is required in dividend payouts. Executives participating in a Nov. 10 conference call refused to be drawn out by analysts who questioned if the dividend will be reduced.

Chevron Corp., meanwhile, has been adamant in pledging to uphold payouts to investors, which rose 7 percent in April to $4.28 annually.

The San Ramon, California-based explorer said in a Nov. 7 regulatory filing that it “can modify capital spending plans during extended periods of low prices for crude oil and natural gas, and narrow margins for refined products and commodity chemicals, to provide flexibility to continue paying the common stock dividend and maintain the company’s high-quality debt ratings.”

Chevron so far has lived up to its word. During the first nine months of this year, as crude dropped below $100 a barrel, the company devoted $33 million a day to dividends and share buybacks, unchanged from a year earlier when crude averaged $108.49 a barrel.

To contact the reporters on this story: Joe Carroll in Chicago at [e-mail]; Bradley Olson in Houston at [e-mail] To contact the editors responsible for this story: Susan Warren at [e-mail] Will Wade