The price of West Texas Intermediate crude oil, the U.S. benchmark, briefly passed $80 per barrel last week. It's the highest oil has been since the crash of 2014. At over $5.15 per million Btu, Henry Hub natural gas prices are also at their highest levels in roughly seven years.
Investors may be tempted to jump into leveraged drilling companies or concentrated exploration and production businesses. But there's a simpler, and safer, option. Chevron (CVX 0.75%), one of the world's largest integrated oil majors, is a great way to get a sizable 5% dividend yield while exposing your portfolio to the booming oil and gas market. Here's why.
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A primer on why oil and gas prices are rising
WTI oil prices averaged $39.17 per barrel in 2020 and $56.99 per barrel in 2019. In December 2020, the U.S. Energy Information Administration's monthly short-term energy outlook forecast 2021 average WTI oil prices at just $45.78 per barrel. The EIA couldn't have been more wrong.
2021 has seen its share of headlines. Meme stock mania, a growing and maturing cryptocurrency marketplace, and the ongoing dominance of megacap tech stocks like Apple have all garnered their fair share of attention. One of the lesser talked about stories has been consistently strong oil and gas prices.
New renewable energy installations are now cost-competitive with fossil fuels. A growing interest in carbon neutrality and environmental, social, and governance investing are pushing both public policy and corporate strategy toward environmentally sound solutions. Despite this strong long-term trend, the reality is that the global economy still runs on oil and natural gas.
Oil prices have spent most of 2021 above $60 per barrel because demand is rebounding as the economy reopens and because supply is low. Supply is likely to stay low because oil and gas producers aren't ramping production to capitalize on higher oil and gas prices like they used to. One way to follow this is by looking at the rig count, which tracks drilling activity. Another is by following spending patterns of companies, which remain relatively reserved despite higher prices.
Total World Rig Count data by YCharts
There are many reasons for this behavior, but the simple explanation is investor pressure to limit leverage (low debt) and run a business that can succeed in good times and survive downturns (lower growth, better consistency), and a collective effort to reduce carbon emissions by investing in alternative energy. Add it all up, and there's simply less money going toward growing global oil and gas production. If prolonged, that could mean higher oil and gas prices for an extended period.
Reasons why Chevron is an elite oil and gas company
Oil prices may be at a seven-year high, but that doesn't mean it's a good idea to buy risky stocks with wobbly fundamentals.
Chevron's strong balance sheet and capital discipline were put on display in 2020. The company was able to buy Noble Energy, which has a lot of acreage in the Permian Basin, at a good price without straining its balance sheet. The idea was to integrate Noble's attractive assets into its already sizable Permian position to drive profitability.
Just a few years ago, Chevron was spending a lot of money to develop megaprojects like Wheatstone, a liquefied natural gas plant in Australia. Now, it's entered a period of lower spending, making it relatively nimble for an oil major. Limited capital commitments give the company flexibility to shift its focus toward projects with low break-even levels, meaning they can turn a profit even if oil and gas prices are weak. Achieving positive free cash flow at $40 oil and below has been Chevron's core strategy. It's a conservative game plan that ensures it can do just fine even if oil and gas prices cool off.
In its 2021 investor presentation, the company outlined how it expects its business to perform during a $40 oil environment and a $60 oil environment. At $40 oil, Chevron would generate plenty of cash from its operations -- but would need to raise debt to cover its dividend obligation. Still, its debt levels would only increase to around the industry average of its peers. At $60 oil for five years, it expects to generate around $25 billion in extra cash that it says would largely go toward its shareholders through dividends and buybacks.
A balanced way to invest in a boom
If oil and gas prices continue their ascent, there will undoubtedly be smaller or higher-leveraged companies that benefit more than Chevron. But it gives investors a much better chance at benefiting from higher oil and gas prices without the downside risk. Aside from its industry-leading balance sheet and diversified operations, the company has a 5% dividend yield and is a Dividend Aristocrat, meaning it has raised its dividend for over 25 consecutive years, something very few energy companies have done. Add it all up, and Chevron is a great option for retirees looking to supplement income, dividend investors, or anyone looking for a blue chip oil and gas giant with room to run.
