Saturday 17 January 2015

How about those falling oil prices – Adding BP to my High Dividend Yield Portfolio

Unless you've been living under a rock you will be very familiar with oil prices falling for a few months now.  Regular readers will know that I have a monster commute so I’m certainly noticing the difference at the petrol pump.  That said I also have Royal Dutch Shell within my High Yield Portfolio (HYP) which as I write this post is now under water by 15.3%.   Search online for some oil data and you won’t have to go far before you find a chart not unlike this:

West Texas Intermediate Crude Price ($/barrel)
Click to enlarge

I have a problem with these types of charts because the unit of measure used to compare oil against is being constantly devalued through inflation.  Let’s therefore correct for that:

Real West Texas Intermediate Crude Price ($/barrel)
Click to enlarge

With West Texas Intermediate Oil (WTI) for February delivery settling at $48.69 a barrel on the New York Mercantile Exchange the real oil price is certainly now below the trend line.  It’s also 15% below the real average of $57.08 but it’s 7% above the real median price of $45.57.   What do you think, is oil now over or under valued?  Personally, I’m not even going to think about it because I’ve proven in the past that I’ll probably lose money if I do.  What I do know is that the oil price change has had a big effect on the share price of Oil & Gas Producers like Shell and BP.  It’s also had a big effect on Oil Equipment, Services & Distribution companies like AMEC Foster Wheeler and Petrofac.

The falling company prices have then caused BP to rise towards the top of my HYP watchlist of 136 companies.  Subsequent analysis, which doesn't consider whether prices will rise or fall further in the short term, but is instead focused on purchasing high yielding shares for the long term, also looked interesting.  This week I therefore pulled the buy trigger and added 1,131 shares to my HYP at a price of £3.9477.

Let’s review the key criteria in a little detail:
  • The BP business model is very easy to understand and I’m sure nearly everyone knows what they do without research.  They provide fuel, energy, lubricants and other petrochemical products for everyday items.  They have their fingers in the pie from pulling crude oil out of the ground or sea all the way to the petrol station you might fill up from.
  • I prefer large and non-cyclical industries.  It’s certainly large with around 84,000 employees and some $380 billion in revenues.  I do however acknowledge that it is very exposed to oil price changes which is what we’re seeing today.
  • I already own Royal Dutch Shell, another Oil & Gas Producer, so I am breaking a rule here as I should have been adding a new industrial sector to my HYP.  I've broken this rule previously when I added GSK when I already owned Astra Zeneca so I have form here.  Today against my buy price GSK is underwater by 0.4% or £16 but a little in their defence they have paid me £116 in dividends since the purchase.
  • I'm looking for shares with dividend yields somewhere between the current FTSE 100 yield of about 3.5% and 1.5 times the FTSE 100 yield or 5.3%.  On a trailing yield of 5.9% BP is therefore a little over the top.  Forecast dividend is currently even higher at 6.3%.
  • The company should have an unbroken history of continually increasing dividends plus dividends that increase at a rate equal to or greater than inflation.  The Deepwater Horizon oil spill in the Gulf of Mexico which started on the 20 April 2010 saw the dividend more than halved from $0.56 to $0.21 per share.  However, in the 4 years since the disaster dividends have increased year on year and are now up by a total of 76% to $0.37.  This is significantly above inflation.
  • A dividend cover of greater than 1.5 for all HYP type shares except utilities where I think that greater than 1.25 is ok.  Here BP passes with flying colours sitting on 3.3.
  • ‘Creative accounting’ can make earnings and hence dividend cover look good.  I therefore also set a greater than or equal to 2 criteria on Operating Cash Flows compared to Dividends.  At 3.0 this also looks pretty healthy.

So I've doubled up on sectors, BP doesn't have an unblemished dividend history, the high dividend yield is a little over the top and I'm sure oil prices are going to hit profits in the short term.  That said I'm not buying for the short term but rather with a fair wind for the rest of my life.  Is BP a contrarian play – with the Brokers surveyed by Digital Look suggesting a Strong Buy certainly not.   Is it a foolish play – well only time will tell on that one.  Is it a mechanical play based on my long ago selected criteria – yep it’s pretty close to one of those.

As always DYOR.

  • US inflation data for December 2014 and January 2015 is estimated.


  1. - Exposure to a single company while its main product is very volatile
    - No analysis of the balance sheet and other financials including debt (how do u say?do your own research?)
    - Significant drop of revenue is expected and not clear if oil would go back and when
    - So sounds like oil price speculation....

    1. Hi K

      Given my current high yield shares and that you don't seem a current fan of companies that depend on oil would be interested in your thoughts. If today you had my HYP and were looking for the next company to add with criteria above FTSE100 yield and an ability to increase dividends at a rate greater than inflation who would you buy?

      Meant to ask you last week also. Did you go active or tracker with your Corp Bond and EM fund purchases? Would be interested to know which funds you jumped into?


    2. Ok, my bad. Till recently I have been more equity person expecting a
      the return of inflation, likely too naive with the whole debt around. Also I have 20 years before retirement. I cannot say about dividends much as i have more growth funds.

      corp bond is active - Stan Life Long Corporate Bond Pn, no specific reason actually . All active funds are for risky - em and small caps. I am in passive only where I invest in "market".

      I am also starting highly speculative bet in oil/Russia long term - Neptune Russia & Greater Russia.

    3. Thanks for that. Your Corporate Bond thoughts have had me thinking over the last few days. I now have a lot of my wealth tied up in UK PLC (well into 6 figures) in the form of UK Index Linked Gilts and NS&I Index Linked Savings Certificates. I've started looking at the possibility of diversifying into some Corporates from a risk management perspective. Before your reply I'd come up with the iShares Core £ Corporate Bond (SLXX) with a TER of 0.2%.


      interesting talk, i actually agree on the number of items


    1. An interesting read, thanks. This was an interesting statement about supply and demand -"When markets are severely over-supplied, as they are now, there is almost no price that is too low".

      In brief the author is suggesting continued over supply in the short term so we're going lower still (Spring '15?), but then into 2016 as shale gas investment potentially dries up (which needs high CapEx spend) we could quickly see shortfalls in supply.

      I read somewhere recently (BP data?) that some are thinking lower prices for 3 or so years. So the author is far more bullish than that.

      Given I'm buying for the long term (the rest of my life) the volatility over the short term doesn't concern me provided BP and RDSB doesn't become insolvent. I'm simply looking for real dividend increases over that long term.

  3. Nothing at all to do with BP !

    I have been thinking about annuities - particularly in light of the very significant changes that will occur to pension pot options and choices in April 2015.

    The issue of choice of annuity : index-linking ( CPI / RPI ) , with profits , flat rate and fixed annual increases of different amounts.

    How have retirees fared over the last 10 / 15 years ? Those that paid for index -linking may well be out of pocket compared to those who opted for a 3 /4 or even 5 % annual increase in their annuity payments . And how have with profits funds performed over this time ?

    Actually - BP does have some relevance to this . The benefits of investing in pensions are increasingly being eroded by the advantages of ISA's as a competitive retirement vehicle . The longer you live whilst drawing your pension - the more tax you will pay on this income - and a s this is deducted at source - there is little way of avoiding having to pay it .

    So - the cost of any retirement income ( in this case from an annuity ) is very relevant - when you are comparing it to - say - a HYP held in an ISA for the rest of your life.

    1. Thanks as always for sharing stringvest.

      Thinking about your comment "The longer you live whilst drawing your pension - the more tax you will pay on this income". As long as the tax rate on the way in is the same as on the way out then it doesn't make any difference. For example Investor 1 socks £10k into a 'pension' that returns 10% annually for 10 years then pays 20% tax on the withdrawal = £20.7k. Investor 2 socks £8k into an 'ISA', as he's paid 20% tax on the way in, that returns 10% annually for 10 years = £20.7k.

      Of course the elephant in the room is that tax rates in aren't necessarily the same as tax rates out. I use pensions as part of my overall strategy for the 25% tax free lump sum (which might not be relevant if I retire overseas) as well as that I expect to be a basic rate payer in retirement vs a higher rate payer now. So I'm miles ahead before I even consider employer matches and NI contributions.

      This is of course balanced against issues like government tinkering and the IMHO likelihood that taxes are going to rise in the future.

      I've also been mulling annuities a little also. I was once very anti but now with a big chunk of wealth staring me in the face it gets you thinking a little differently. I've been thinking about long term risk particularly around sequence of portfolio returns and life expectancy. I'm a long long way off but in a quiet moment have wondered whether if I ever get to 75+ whether I should put a big chunk in an index linked annuity as an insurance policy as well as protection in case I lose my marbles.

  4. I think your purchase of BP is a solid buy if you're going for the long term. :)

  5. I hold BP at the moment. It's probably a reasonable bet but I hate to say more than that as I'm allergic to crystal balls. I might buy Shell too at this rate, having only recently sold it in August for a short-term profit just before the bottom fell out of the oil price (luck of course, rather than skill).

    I think both are relative low risk, although the elephant in the room is climate change, solar etc. In a decade or two oil could be $10 dollars but with little demand due to super cheap and efficient solar or other sources. Of course, what do I know? But in my opinion it is an industry headed for major disruption at some point in the next few decades.

  6. I'm sure you'll have answered this before, in which case apologies for asking you to repeat yourself.

    The HYP seems fascinating, but I struggle to understand the motivation for trying to identify worthwhile individual companies and buying individual shares, with all the risk and fees that entails, rather than simply buying e.g. Woodford, which appears to deliver exactly what you're after.

    What am I missing? Without wishing to seem provocative, do you know something that Neil doesn't?

    1. "...with all the risk and fees that entails...". That's actually one of the reasons I'm DIY with the HYP. Mr Woodford will charge me 0.6% per annum for the privilege of being admitted to his club. By buying direct I have no ongoing expenses and my buy costs are insignificant as I buy through a low cost broker in significant chunks. So the question becomes will Mr Woodford outperform my HYP by 0.6% every year forever? I have no idea but my approach is saying no.

      The second reason is that I'm in this for the very long term - my whole life. That could be 40 or 50 years. I don't think Mr Woodford is in it for that long. Will Mr Woodford's replacement be as good. Who knows but I know that I'll still be me.

  7. The Great Pension Liberator has decreed that the beneficiary can take the pension tax-free from a joint life annuity, if the purchaser dies before 75. I am now wondering how to turn that to our advantage. How do I lay off the bet on my dying before 75? Should I simply not bother on the grounds that the longer I live the greater our household income anyway? Maybe that second point of view is the wiser?