Big oil's biggest problem is its shareholders

Over one trillion dollars has been wiped from U.S. oil and gas company valuations since mid-2014, yet lavish dividends are still flowing into investors' pockets.

While oil has rebounded above $40 per barrel from February lows of $26, the outlook for many energy companies remains bleak. Exxon (XOM) announced that its first quarter profit dropped 63%. At the same time, Chevron (CVX) posted a loss—its worst showing in over a decade. Shell (RDS-B) also posted a huge earnings decline of 58%, while BP (BP) had a 79% fall from the year before.

But despite a loss of over $6 billion last year, BP still paid over $6 billion to shareholders—and it announced it would take on even more debt to maintain its dividend.

Exxon’s fall from ratings grace

Most of Exxon's 2015 profits were simply funneled to shareholders ($12 billion of its $16 billion in net income), which is part of the reason that S&P stripped Exxon of its gold-plated AAA rating status.

Yet Exxon just hiked its dividend again by $0.02 to $0.75 per share, following a tradition of over three decades of dividend increases. Exxon shareholders currently receive a 3.4% dividend return—well above the 2% return for the overall market.

"Exxon had two choices: to continue down the path of increasing its dividend, or not. If they didn't up the dividend, it would have been a big deal, especially after 33 years of increases," said Howard Silverblatt, senior index analyst for S&P Dow Jones Indices.

S&P raised concerns about Exxon's debt burden as a justification for cutting its rating, noting that its debt has “more than doubled in recent years, reflecting high capital spending on major projects in a high commodity price environment and dividends and share repurchases that substantially exceeded internally generated cash flow.”

Sustainability of energy dividends

The big dividends make energy companies more attractive to investors, but there's a looming problem that was brought to light during the last oil price plunge: shareholder returns at these levels might not be sustainable.

Earlier this year ConocoPhillips (COP) reduced its dividend by 66%, a move that took many investors by surprise. Chief Executive Ryan Lance called it a "gut-wrenching" decision, but a necessary measure to weather the downturn in oil prices.

However, ConocoPhilips faces different circumstances than Exxon and Chevron. Many oil companies have been able to stay afloat with low oil prices because they rely on a wide array of businesses, from exploration to drilling, to refining. While the exploration business has suffered, refining operations have boomed during the oil glut. ConocoPhilips, unlike Exxon and Chevron, no longer has a refining unit.

"You’ve got to put together some kind of package where you’re going to protect your shareholders and you’re going to protect your balance sheet," said Dan Dicker, president of MercBloc. "I thought Conoco went too far in one direction by cutting the dividend, while BP went too far in the other direction by saying that they’re willing to increase their debt load. Someplace in the middle is where I’d like to be."