Crude oil prices have gotten off to a great start in 2021. West Texas Intermediate, the main U.S. oil price benchmark, has rallied about 25% so far this year, recently topping $60 a barrel. A rally like that is usually enough to entice oil producers to ramp up their drilling programs.
However, Diamondback Energy (FANG 0.57%) plans to go against that industry norm by putting a firm lid on its output this year. That will enable it to generate excess cash at higher oil prices that it can use to repay debt and reward shareholders.
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Resiliency amid the storm
Diamondback Energy delivered solid results in 2020 despite all the turbulence in the oil market. It generated about $2 billion in operating cash flow, which covered the $1.86 billion it invested into drilling new wells. Overall, it brought 171 new wells into production, enabling it to produce an average of 300,331 barrels of oil equivalent per day (BOE/D) and 180,825 barrels of oil per day (BPD). While its overall output increased last year from 282,972 BOE/D in 2019, oil production declined from the prior year average of 187,721 BPD.
Because Diamondback Energy kept capital spending below operating cash flow, it generated $162 million of free cash flow for the year. That's due to a strong end to the year as the company produced $468 million in operating cash flow but only spent $226 million on drilling new wells, enabling it to generate $242 million in free cash.
Keeping a lid on production
While oil prices have rebounded sharply in recent months, Diamondback Energy doesn't plan on restarting its growth engine. That's because the company is "still operating in a market supported by supply that is being purposely withheld to allow global inventories to decline as demand recovers from the depths of the global pandemic," CEO Travis Stice said on a recent earnings call. "Diamondback continues to see no need to grow oil production into this artificially undersupplied market." As a result, Diamondback Energy plans to hold its production rate flat with its 2020 exit rate.
The company expects to invest between $1.35 billion and $1.55 billion into drilling and completing new wells and related infrastructure. That should enable it to produce between 178,000 and 185,000 barrels of oil per day. As a result, it expects to deliver more than $625 million of pre-dividend free cash flow this year. That gave it the confidence to boost its dividend by 6.7%, pushing the yield to around 2.4%. The company also plans to use some of its excess cash to repay debt, strengthening its already solid balance sheet.
It's worth noting that while Diamondback Energy's outlook factors in its pending acquisition of Guidon Energy, it doesn't account for its all-stock deal for QEP Resources (QEP). The company is on track to close the $862 million Guidon deal this week. Meanwhile, the $2.15 billion transaction for QEP Resources should close by the end of the first quarter. Diamondback plans to provide updated guidance when the deal closes. However, the current theme will remain in place to keep its 2021 production flat with where the combined entity ended last year.
While the company's near-term focus will be on integrating those assets and generating free cash flow to repay debt, Diamondback could return additional cash to shareholders this year above its recently increased dividend. That could come in the form of share buybacks, another increase in its base payout, or additional dividends.
Getting stronger in 2021
Diamondback Energy navigated last year's oil market crash exceptionally well. It cut spending, which enabled it to produce free cash and maintain a strong financial position. That gave it the flexibility to pounce on opportunities to buy QEP Resources and Guidon Energy. As a result, it's on track to generate a significant amount of free cash flow this year, which will allow it to further strengthen its balance sheet and return cash to investors via a higher dividend for now, with the potential for more later this year. Because of that, it looks like it's in a solid position to create shareholder value if oil prices cooperate.
