Oil stocks have a shoddy track record for paying dividends. For the most part, their shareholder payouts are the first things they cut when crude oil prices take a tumble. Dividend investors have been increasingly looking elsewhere for income.

Leading Pioneer Natural Resources (NYSE:PXD) is shaking things up a bit by formalizing a new dividend framework. It could become a big-time dividend stock if oil prices continue recovering.

A person holding a bag with the word dividends on it.

Image source: Getty Images.

Positioned to prosper at lower oil prices

Pioneer Natural Resources has concentrated on reducing its operating costs so that it can thrive at lower oil prices. It showcased its success last year, when the company produced nearly $700 million in free cash flow despite all the turbulence in the oil market. Meanwhile, it's on track to reduce costs further via the recently completed acquisition of Parsley Energy. The combined company has an oil breakeven price in the high $20 a barrel range. That's the average oil price it needs to generate enough cash for drilling more wells and maintaining its current production rate. 

Thanks to that ultra-low breakeven level, Pioneer Natural Resources can thrive at lower oil prices. For example, it estimates that it can produce $4.6 billion of operating cash flow this year at $55 oil. That's noteworthy since it's below the recent price of around $62.50 a barrel. The $55 a barrel price point would provide it with enough money to fund its $2.5 billion to $2.8 billion capital program with more than $2 billion to spare. 

An oil pump and barrel on top of money.

Image source: Getty Images.

A solid base with monster upside

Pioneer Natural Resources used to reinvest nearly all its excess cash on drilling more wells to expand its output. However, that strategy has burned the industry by oversupplying oil. Pioneer plans to return the bulk of its free cash flow to investors in the future.

It aims to pay a sustainable and growing base dividend that it complements with a variable dividend. The company recently increased its fixed quarterly dividend to $0.56 per share. That's up 1.8% from the prior level and represents its fourth consecutive annual increase. That nudged the oil company's dividend yield to around 1.5%, which is around the same level as the average stock in the S&P 500. Pioneer Natural Resources can sustain that dividend at an average oil price of $33 a barrel when factoring in enough capital to maintain its production rate. 

On top of that base payout, Pioneer Natural Resources plans to layer in a variable dividend. The company expects to distribute up to 75% of the previous year's annual free cash flow after paying the base dividend as long as its leverage metrics remain low. The company plans to begin these payments in 2022. It's capping its first year's variable dividend at up to 50% of its post-dividend free cash flow as long as oil prices average at least $42 a barrel this year, which is the level needed to finance its capital program and base dividend. The company intends to utilize the rest of its excess cash to further strengthen its balance sheet.

Pioneer Natural Resources' variable dividend framework is almost a mirror image of Devon Energy's (NYSE:DVN) new dividend policy. The only difference is that Devon plans to pay a variable dividend of up to 50% of the prior quarter's post-dividend free cash flow. It has already declared its first variable dividend, which, at $0.19 per share, is more than double its quarterly base payment or $0.11 per share. Devon's initial payout shows the upside potential of Pioneer's variable dividend. It could be much more than its quarterly dividend, especially following a year of high oil prices.

A new approach to dividends from the oil patch

Oil companies are looking for better ways to allocate the cash they produce to create shareholder value. Reinvesting it into new wells hasn't worked, nor has share buybacks or high fixed dividends. That's leading Pioneer to follow Devon's strategy by launching a fixed-plus-variable divided. While its investors will have to wait a year for their first extra payment, it could be a gusher considering that crude oil prices are well above the company's breakeven level.

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.