Image source: ConocoPhillips.

ConocoPhillips (NYSE:COP) used to be one of the top dividend stocks in the oil sector. In fact, the company went so far as to say that maintaining a growing dividend was its top priority. However, plunging oil prices have a tendency to change priorities, and that was certainly the case with ConocoPhillips after the company slashed its payout by two-thirds earlier this year to conserve cash. With oil prices improving and its business now in a much better position to run at lower oil prices, however, a dividend increase could happen as early as next year.

A dividend-paying company at the core

While ConocoPhillips' dividend took a hit during the downturn, CEO Ryan Lance wanted to make one thing clear. He said that "the dividend will remain a core part of our offering and we're targeting real annual growth in that dividend." He went into further detail on the company's plan for the dividend on the second-quarter conference call by saying:

The first use of cash is to pay our existing dividend and invest capital to maintain our production base. Now, let me be clear that flat production is not our goal; but at a minimum we want to sustain our existing production...After our cash from operations exceeds the level required to cover our dividend and capex for flat volumes, the next use of cash will be to grow our dividend annually at a real rate. We think this is a prudent and sustainable target. Our next priority is to reduce our debt to below $25 billion...Next we have a target to achieve 20% to 30% total shareholder payout of cash flow from operations through a combination of our ordinary dividend and flexible share repurchases. We don't believe our ordinary dividend represents enough return of capital to shareholders through the cycles for a company our size and maturity; so when we have available cash flows we expect to return additional capital through share buybacks.

In other words, as soon as cash flow from operations covers its current dividend and maintenance capex, investors can expect the company to increase its payout. Then, once it reaches its debt target, the company plans to increase the payout some more and start buying back stock. That said, as the slide below shows, ConocoPhillips has some work to do before it hits either target:

Data source: ConocoPhillips investor presentation.

As that chart notes, the company generated $1.9 billion in cash flow from operations through the first half of the year, which did not come close to covering the $3.6 billion it spent on capex and dividends. Also, its total debt stood at $28.7 billion, which remains above its $25 billion target.

About to turn the corner

While it is anyone's guess when these objectives will be reached, analysts at RBC ran the numbers using ConocoPhillips' stated goals and their oil price projections. As a result, they estimate that "the current dividends alone would reach that target [of returning 20% to 30% of operating cash flow to shareholders] in 2016." However, they noted that based on their 2017 oil price forecast of $59 per barrel, there's upside potential for shareholder payouts. In fact, RBC expects ConocoPhillips to increase its dividend by 4% and authorize a $500 million share buyback in 2017 to "put money into shareholders' pockets."

In the near term, it would seem that low-single-digit dividend growth is about all investors can expect from oil companies coming out of the worst downturn in decades. Producers need to balance the possibility of another setback in the oil market with other capital allocation priorities. That is why fellow oil giant Occidental Petroleum (NYSE:OXY), for example, only boosted its payout by a mere 1.3% this year. Occidental Petroleum's commitment to growing its payout on an annual basis drove its decision to give its investors a modest increase.

That said, the company has several other options that are competing for its limited capital including organic growth, share repurchases, and acquisitions. M&A is of particular appeal to Occidental Petroleum, and because it would be willing to issue equity for the right opportunity, it needs to be mindful that additional shares mean a higher total dividend payment. In ConocoPhillips' case, growth spending either on capex or to buy back shares to boost production on a per-share basis will likely be the main competition to dividend growth in the near term.

Investor takeaway

It seems unlikely that ConocoPhillips will be able to boost its dividend this year. However, there is a growing likelihood that the payout will head higher in 2017, even if it is only a token increase. In any case, the company appears to favor share repurchase as its primary vehicle to boost shareholders returns and production per share going forward.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.