Oil producers are an obvious beneficiary of high oil prices. As crude prices rise, they can capture those higher prices and sell their output for more money.
However, many other energy companies also benefit from higher oil. Midstream companies often receive a dual benefit from rising crude prices. They can earn higher margins on some of the services they provide to the industry. In addition, they should see higher volumes flow through their systems. That should give them more fuel to grow their dividends in the coming years.
Two under-the-radar energy stocks that should benefit from higher crude prices are Crestwood Equity Partners (CEQP) and DCP Midstream (DCP). Here's a look at what's fueling their upside potential.
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Dual upside catalysts
Like most midstream companies, Crestwood Equity Partners generates relatively predictable cash flow. Most of its revenue comes from fixed-fee or take-or-pay contracts that provide steady income. However, the master limited partnership (MLP) does have some leverage to higher commodity prices due to variable-rate agreements, primarily from processing natural gas to extract natural gas liquids (NGL) like propane and ethane. Overall, 17% of its cash flow comes from these variable-rate contracts. Given the current higher energy prices, that provides it with some upside potential in 2022.
Another benefit of higher oil and gas prices is that they incentivize producers to drill more wells, driving more volumes across Crestwood's system. Higher projected oil producer activity in 2022 is also supporting new expansion projects. The company expects to invest $160 million to $180 million to build new midstream infrastructure to support its customers, up from only $50.7 million last year. Those expansions will help grow its cash flow in the coming quarters as they come on line.
Meanwhile, if prices remain high, producers could further ramp up their drilling activities, providing more growth opportunities for Crestwood.
Crestwood estimates that it could produce $500 million to $600 million in free cash flow this year, assuming oil averages between $75 and $85 a barrel. That's enough money to cover its 8.5%-yielding dividend by 2 to 2.2 times.
And with oil currently over $100 a barrel, Crestwood could top the high end of that cash flow outlook. That could give it more money to return to shareholders in the coming years. It has already boosted its distribution by 5% this year and could provide an even bigger increase if oil stays elevated.
Lots of upside potential
DCP Midstream has a similar upside profile as fellow MLP Crestwood. Overall, the company gets about 70% of its revenue from stable fee-based contracts. On top of that, it uses hedges to lock in another 12% of its projected cash flow in 2022 on the production coming out of its natural gas processing plants. It leaves the remaining revenue stream unhedged. That allows it to participate in the upside of more-favorable energy prices, which we're seeing this year.
Meanwhile, DCP Midstream can lock in higher prices as legacy hedging contracts roll off. That should drive steady earnings growth from those volumes in the coming quarters.
Lastly, the company should benefit from higher volumes flowing through its midstream assets as its producing customers seek to cash in on higher prices. Its customers could ramp up their output, which would push more volumes across its existing infrastructure while providing new expansion opportunities.
As things stand, DCP Midstream expects to produce between $900 million to $1.01 billion in cash flow this year. After funding its 5%-yielding distribution and $100 million to $150 million in growth capital projects, it anticipates producing $425 million to $585 million in free cash flow. The company based its budget on oil averaging $70 a barrel this year.
DCP Midstream could produce even more excess cash with oil considerably above that level. That could enable it to return more money to investors, including increasing its distribution and repurchasing some of its common or preferred equity.
High yields with some oil-fueled upside potential
Crestwood Equity Partners and DCP Midstream generate a lot of stable income backed by long-term fixed-rate contracts, which helps support their high-yield dividends. On top of that, these MLPs have some leverage to higher oil prices via variable-rate contracts and unhedged production at their natural gas and NGL processing plants.
In addition, as more volumes flow through their systems, it should allow them to make high-return investments to grow their capacity. Because of all this, they might exceed the high end of their cash flow projections this year. That could give them even more money to return to shareholders in the coming quarters.
