What happened

Shares of Pioneer Natural Resources (PXD -0.67%) declined by 10.6% in July, according to data provided by S&P Global Market Intelligence. Weighing on the oil stock were lower oil prices and its oil hedging program. 

However, despite that decline, shares of Pioneer Natural Resources had surged 27.6% year to date through the end of July. They renewed their rally in August after the oil producer reported its second-quarter results

The silhouette of a person next to an oil well.

Image source: Getty Images.

So what

Oil prices moderated a bit in July. West Texas Intermediate, the primary U.S. oil benchmark, fell from its peak above $75 a barrel at the beginning of the month to a few dollars below that price point by month-end. Weighing on crude prices was OPEC's plan to bring back more supply during the second half of the year, and a surge in COVID-19 cases worldwide as the delta variant spreads. 

However, oil prices are much higher than producers expected this year. That caught Pioneer by surprise as it was one of many oil companies that used hedging contracts to lock in pricing at lower levels. Because of that, it's now losing money on those hedges. It warned in late July that it could record an $832 million loss on its oil and gas hedges when it reported its second-quarter results in early August. 

That loss turned out to be less than the company anticipated. Pioneer reported $380 million, or $1.54 per share, of net income for the quarter. After adjusting for losses on its hedging contracts, it would have earned $629 million, or $2.55 per share. 

In addition to that better-than-expected result, Pioneer produced a gusher of cash flow in the quarter, tallying $616 million of free cash flow after funding its capital expenditures. That strong result gave the company the confidence to accelerate and increase its variable dividend program. The company had planned to start paying supplemental dividends next year based on 2021's free cash flow. However, it's paying the first one this year. It's also distributing 75% of its second quarter's free cash flow, up from its initial expectation that it would pay out up to 50% of its free cash in the first year. That inaugural variable dividend is almost three times the company's regular quarterly payout. 

Now what

While oil price volatility weighed on Pioneer Natural Resources last month, it ended up producing increased free cash flow for the second quarter. That enabled the company to return a windfall to shareholders. As long as oil prices remain high, Pioneer should continue paying sizable variable dividends to complement its already above-average base payout.