Building an investment portfolio of high-yielding dividend stocks is a great way of generating passive income.
Due to their potential for producing huge amounts of cash, oil companies have a reputation for paying generous dividends. There are two in the FTSE 100 — Shell (LSE:SHEL) and BP (LSE:BP.).
What level of passive income could I earn from them?
Should you invest £1,000 in BP right now?
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Overview
The first thing to acknowledge is that they’re not just oil companies. They also sell gas and trade energy. But their earnings are heavily influenced by the price of ‘black gold’, changes in which tend to feed through to gas prices.
Last year was a good one for the two energy giants.
Russia’s invasion of Ukraine helped drive commodities higher, resulting in both companies reporting their biggest annual profits since they started trading.
But this year isn’t going to be as profitable. At $80 a barrel, year-to-date oil prices are currently 20% lower than they were in 2022.
However, many forecasters are predicting prices will average $85-$90 in 2023.
| Year | Average closing price of Brent crude ($ per barrel) |
| 2013 | 109 |
| 2014 | 99 |
| 2015 | 53 |
| 2016 | 45 |
| 2017 | 54 |
| 2018 | 71 |
| 2019 | 64 |
| 2020 | 42 |
| 2021 | 71 |
| 2022 | 101 |
| 2023 (to date) | 80 |
Income
AJ Bell is expecting Shell to pay dividends of 98p this year, and BP, 22p. This implies yields of 4.2% and 4.8%.
A £5,000 investment in each stock would generate annual passive income of £450.
But by reinvesting the dividends, and assuming no growth in either these or stock prices, I could generate £709 a year within 10 years. That’s a yield of over 7%.
However, dividends are never guaranteed. Indeed, BP cut its payout by 50% in 2020. Despite its record-breaking year, shareholders received 41% less in 2022 than two years’ earlier.
But, in my opinion, the present dividend for both companies looks affordable.
Aware of the outcry that would follow a cut, I think they’ve deliberately set the current payouts at levels that can, at least, be maintained.
If there was a sharp drop in energy prices I reckon they would first curtail their expensive share buyback schemes. These cost more and don’t return cash directly to shareholders.
| Year ended 31 December 2022 | Shell | BP |
| Cash flow from operations (CFFO) ($bn) | 68.4 | 40.9 |
| Dividends ($bn) | 7.6 | 4.7 |
| Share buybacks ($bn) | 19.0 | 10.0 |
| % of CFFO returned to shareholders | 38.9 | 35.8 |
Cheap?
At the moment, both shares appear to offer good value.
Shell reported adjusted earnings per share (EPS) of $1.39 (£1.09) in the first quarter of 2023. Assuming this is repeated for the next three reporting periods, its price-to-earnings ratio is currently 5.3.
Applying the same methodology to BP (EPS: 27.74 cents / 21.83p) gives a figure of 5.2.
The FTSE 100 average is around 10.
Final thoughts
Investing in oil companies has many associated risks. Fluctuating energy prices can lead to volatile earnings.
The industry is also dangerous. BP is still paying compensation to victims of the Deepwater Horizon oil spill of 2010.
And big oil fails many ethical, social, and governance tests, making it unacceptable to some investors.
But, as unpalatable as it might be, we need these fossil fuels — peak demand for oil is not expected until 2035-2040.
As long as they’re law-abiding and pay their taxes, I don’t have a problem owning shares in either Shell or BP.
However, I’m not going to invest at the moment because I don’t have any spare cash.
But I expect big oil stocks to become cheaper over the summer as demand in the northern hemisphere falls. If I’m right, their yields will increase. I will therefore reassess the investment case in September when, hopefully, I will have some money available.
