It's a troubled world when oil is a refuge for equity investors

You know the world is in trouble when investors look to the oil industry for safety.

Oil stocks, the worst performing shares in the world, are starting to lure investors, with dividend yields the highest since the financial crisis that began in 2008.

Their payouts are more remarkable in this era of record-low interest on cash and zero to negative yields on government bonds. Chaos in Greece and tanking Chinese markets only add to investor losses, with more than $3 trillion wiped off global equities in the past month.

Royal Dutch Shell Plc's dividend offers 6.7 per cent on shareholders' cash, a rate not seen since the global financial meltdown and almost double the average for London's FTSE-100 stock index. Morgan Stanley says the extra yield offered by oil companies over the equity market is the most in 30 years.

"Undervalued share prices, continuous high dividend: It's a good time for investors to get into the oil companies," Richard Hulf, co-manager in London of Artemis Global Energy Fund, part of a group overseeing $32 billion for investors, said June 30.

With Europe at the center of the global economic malaise, lending to Germany for 10 years gets you less than one per cent. In contrast, Exxon Mobil Corp. has a dividend yield of 3.5 per cent, the highest since 1996. BP Plc and Chevron Corp. offer rates of 6.8 per cent and 4.5 per cent, respectively.

Cut profit

"Top investors are buying Big Oil as a proxy to a bond," said Norbert Ruecker, commodities research chief at Bank Julius Baer & Co. in Zurich.

Oil companies' share prices, the denominator to the dividend numerator, have collapsed. Energy companies on the benchmark MSCI All-Country World Index of global stocks have sunk 7.1 per cent this year, the worst performance of any industry.

Crude oil prices have fallen by almost half in a year, with the world on the brink of the longest-lasting glut in at least three decades. That cut earnings, with median net income among 15 of the largest integrated oil companies down 45 per cent in the first quarter from a year earlier. The knock-on effects include producers' shrinking spending on the biggest projects and on exploration that will secure future income.

BP Chief Executive Officer Bob Dudley is preparing for a long period of lower oil prices, he said in London last month.

Value trap

Even when prices were at $100 a barrel, some producers were failing to generate enough cash to fund both their investments and dividends. Instead, they took on debt to meet payments to shareholders. Brent futures for September settlement gained 54 cents, or one per cent, to $57.66 a barrel by 11:23 am in London.

"When you see an abnormally high yield relative to the market, that can either be fantastic value or it can be a value trap," Philip Lawlor, a strategist at Smith & Williamson Investment Management LLP in London, which oversees about $25 billion of investments, said Wednesday. "We're underweight on the oil sector."

Brent has tumbled nine per cent this month as demand from a weakening Chinese economy slows and the US pumps more oil. Prices may drop further as the world will remain "massively oversupplied" before markets tighten in 2016, the International Energy Agency said Friday.

In 1986, when oil prices collapsed to $10, the biggest European producers shrank capital spending by a quarter and operating costs on oil and gas output by about a third, Morgan Stanley said in a report published on June 29 with the Boston Consulting Group.

That meant a 16 per cent annual return on average in the next decade, compared with 12 per cent for the wider European market, the report shows. This time, oil companies have to lower costs by 20 per cent to sustain dividends, the analysts wrote.

"The companies are not likely to cut dividends," said Hulf at Artemis. "It's sacred to them."