Conditions in the oil market have improved dramatically in recent months. Crude prices have been red-hot, with the U.S. oil benchmark WTI jumping roughly 25% so far this year to recently top $60 a barrel. Oil companies are starting to cash in on the rally.

One of the potentially biggest beneficiaries is Marathon Oil (NYSE:MRO). It has an ultra-low-cost structure, positioning it to generate a gusher of cash this year and beyond if crude oil prices continue cooperating. 

A barrel standing on a grey floor with money bursting out of it with a happy businessman in a celebrating next to it.

Image source: Getty Images.

Setting up for a monster year

Marathon Oil has spent the past few years repositioning its business to run on lower oil prices. It sold higher-cost assets, using the money to pay down debt and reinvest in lower-cost drillable land across the U.S. That strategy started paying dividends during the fourth quarter of last year. It produced $162 million in free cash flow after financing its capital program, pushing its full-year total to $277 million. The company used that money on shareholder-friendly activities, including reinstating a quarterly dividend, repurchasing shares, and reducing debt. Overall, it returned $150 million to shareholders and paid off $100 million in debt.

Marathon's actions last year position it to prosper in 2021. The company only needs oil to average $35 a barrel to generate the cash to finance its $1 billion maintenance capital program, which will keep its production flat with last year's exit rate. That's slightly below last year's $1.16 billion spending level, which was less than its $1.2 billion budget.

Given that low oil price breakeven level, Marathon estimates that it can produce a gusher of excess cash in 2021. For example, at $50 oil, it can generate $1 billion in free cash flow, implying it can turn 50 cents of every dollar of operating cash flow into free cash. With crude currently well above that level, it's on pace to produce an even bigger gusher of excess funds. For example, at $55 oil, it can deliver more than $1.3 billion of free cash flow in 2021. Marathon plans to use $500 million of that money to pay down additional debt, implying it could return more than $500 million to investors via dividends and share repurchases this year.

Oil pumps with money in the background.

Image source: Getty Images.

Holding the line for the foreseeable future

Marathon plans to continue focusing on producing free cash over the next several years. It unveiled its five-year benchmark maintenance scenario, which envisions investing between $1 billion to $1.1 billion per year on capital projects through 2025. That's enough money to maintain its current production rate while reducing its carbon footprint. A portion of that investment spending will go toward reducing its greenhouse gas emissions by 50% before 2025.

The company can finance that plan at an oil price of less than $35 a barrel. It's thus on track to produce a significant amount of free cash flow over the next few years, even if oil prices decline. At $45 a barrel, it can produce a cumulative $3 billion in excess cash by 2025, with that number rising to $5 billion at $50 oil.

Some of that cash will go toward continuing to enhance its balance sheet via additional debt reduction. Meanwhile, the company will likely eventually allocate some capital to expanding its production when market conditions warrant additional supply. However, it plans to cap production growth at 5% annually. That will allow it to generate excess cash to support incremental returns to shareholders via higher dividends and share buybacks.

Becoming a cash flow machine

Marathon Oil's strategy to turn into a low-cost oil producer is starting to pay dividends. The company is about to turn on the spigots and generate a massive amount of excess cash this year. That could continue through 2025 as long as oil prices cooperate. Most of that money will likely head to shareholders via dividends and share repurchases. That could enable the oil company to produce big-time total returns, making it an intriguing oil stock to watch over the next few years.

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