Oil prices have surged this year. West Texas Intermediate, the primary U.S. oil price benchmark, has risen to more than $100 a barrel, up over 35% since the start of the year. Crude oil had been even higher, topping out at over $130 a barrel at the peak. Even though oil has cooled off since hitting that high, it's well above what most oil companies expected this year.
That's clear from their hedging strategies. Because many oil stocks are locked into pricing much lower than the current level, they won't capture the full upside of higher oil prices this year, since those contracts cap some of their gains. However, three oil stocks with nearly limitless upside to higher oil prices are Marathon Oil (MRO 0.36%), Continental Resources (CLR), and ConocoPhillips (COP 1.23%). They look like the best oil stocks to buy this May for those who are bullish that crude prices will keep rising.
Image source: Getty Images.
Significant leverage to higher commodity prices
Marathon Oil opted to limit its oil hedging activities, enabling it to reap nearly the full benefit of higher oil prices. As the following chart shows, it has some of the highest sensitivity to improving oil prices because it didn't lock in hedges at lower commodity prices:
Image source: Marathon Oil investor presentation.
As a result, there's virtually no cap on the amount of cash flow the company could haul in this year. Furthermore, because the company had racked up significant losses in previous years, it won't pay any cash taxes on its windfall this year. That will enable Marathon to return a gusher of cash to its shareholders in 2022.
The company has already increased its dividend four times in the past year, for total growth of 133%. It also repurchased $1 billion in shares from October of last year through early February, reducing its outstanding share count by 8%. Given its nearly uncapped upside to higher oil prices and tax shield, Marathon could return an enormous amount of cash to shareholders this year if oil prices remain elevated. That could give it the fuel to produce significant total returns.
More income ahead
Like Marathon Oil, Continental Resources didn't hedge much of its oil and gas production this year, so there are few constraints on its ability to capture higher oil prices. That's allowing the company to reap a huge windfall, giving it the cash flow to return more money to investors.
The company recently gave its investors another big-time dividend increase, boosting it by 22%. It has now given investors two raises this year, continuing the steady growth since reinstating the payout last year. There's likely to be more dividend growth ahead. Continental aims to push its dividend yield up from its current level of 1.8% to more than 2% during the 2022-to-2025 timeframe.
In addition to growing the dividend, Continental Resources wants to buy back a significant portion of its outstanding shares. It intends to spend another $1 billion on share repurchases. That's enough to retire 30% of its current publicly traded float.
Meanwhile, as oil prices rise, its cash flow will continue expanding, giving it more money to allocate on behalf of shareholders. It could use that money to retire even more shares or make acquisitions as attractive opportunities arise.
Three ways to win from higher oil prices
ConocoPhillips doesn't use hedges, which is paying massive dividends this year as the U.S. oil giant has unlimited upside to higher oil prices. That's enabling it to generate a gusher of free cash flow, a large percentage of which it plans to return to investors.
The company initially set a target to return $7 billion to investors in 2022 across the following three capital return tiers:
- Pay a fixed quarterly dividend ($2.4 billion annually) that it aims to increase annually.
- Repurchase at least $3.5 billion of shares.
- Make variable return of cash (VROC) payments of around $1 billion.
However, thanks to higher oil prices, ConocoPhillips has already increased its return target. It added $1 billion to the last two tiers, enabling it to accelerate its repurchase pace and boost its VROC payment from $0.20 to $0.30 per share. Given its uncapped upside to higher oil prices, ConocoPhillips could continue allocating more money to those two tiers while also providing investors with a sizable quarterly dividend increase later this year. Those surging cash returns make it look like a top oil stock to buy right now.
Poised to cash in on higher crude prices
While all oil stocks benefit from higher oil prices, Marathon, Continental, and ConocoPhillips have more leverage to crude pricing because of their hedging strategies. That has this trio set to cash in on higher oil prices this year. All three aim to return a growing portion of that windfall to shareholders, making them stand out as the top oil stocks to buy this May to bet on oil prices remaining in the triple digits this year.
