Oil Profits Are Soaring. Here's How to Cash In on the Industry's Gusher.

Oil profits have skyrocketed this year, fueled by surging oil prices. Most oil producers posted gushing profits in the first quarter, which will probably rise further in the second quarter because of higher prices. That's giving them a growing windfall to return to their shareholders.

Here's a look at why oil profits are so high and how you can cash in on the gusher.

What's going on in the oil patch these days

The oil industry has suffered two devastating oil price crashes over the last decade. Crude prices tumbled in 2014 because of an oil price war between Saudi Arabia and Russia and again in 2020, sparked initially by another price war before a knockout blow from the pandemic. Both downturns caused waves of bankruptcies across the industry. It also led investors and lenders to pull capital from the sector, so they didn't get burned again.

Meanwhile, growing climate change fears have made it harder for the industry to operate. Oil companies have significantly reduced exploration spending to find sources of oil on concerns it won't get developed. It has also become more challenging to build new pipelines and other infrastructure because of pressure from environmentalists. That led several oil companies to shift their investments from oil to cleaner alternatives.

As a result, the oil industry has significantly underinvested over the past few years. That's coming home to roost this year. There's insufficient supply to keep up with surging demand, causing oil prices to spike. While there are growing calls for the industry to put its growing profit gusher to work by pumping more oil to ease consumers' pain at the pump, that's easier said than done. 

It takes months to drill new wells and bring them on to production. Meanwhile, there's only so much pipeline capacity to handle more volumes, and it takes even longer to build new pipelines. Finally, the industry doesn't have much spare refining capacity, especially given the number of oil refineries getting converted to make renewable fuels. Because of these and other factors, high oil prices will likely stick around for a while, keeping producer profits gushing.

Rewarding their longsuffering shareholders

Given the industry's headwinds in recent years and the longer-term uncertainty from climate change, oil companies have adjusted their capital allocation strategy. They're capping their investment to the capital necessary to drill enough wells for modest production growth. This allocation strategy freed up money to return to shareholders, allowing oil companies to reward them for their patience during busts with gushing oil dividends during boom times.

With oil prices and profits booming these days, several oil companies are paying monster dividends. One of the leaders in the oil-fueled dividend trend is Devon Energy (DVN 0.78%). The oil company launched the industry's first fixed-plus variable dividend program last year. Devon makes a base fixed dividend payment each quarter that it supplements with a variable payout of up to 50% of its excess cash. Both payments have surged over the past year. Meanwhile, Devon recently made an acquisition that will give it more fuel to grow its dividend in the future.

Pioneer Natural Resources (PXD 0.87%) set a similar policy. The big difference is that Pioneer pays out up to 75% of its excess cash flow in dividends. Its last payment had an implied annual dividend yield of 13%. Meanwhile, Diamondback Energy (FANG 0.57%) set a policy to return half its free cash flow to shareholders. That includes a steadily rising base dividend, with the rest coming from either share repurchases or variable dividends. Diamondback recently paid its first variable dividend, pushing its combined annualized dividend yield to nearly 10%.

Two other oil stocks returning a significant portion of their growing windfall to shareholders are EOG Resources (EOG 1.07%) and ConocoPhillips (COP 1.23%). EOG recently established a minimum to return 60% of its free cash flow to shareholders each year. It's paying a steadily rising base dividend and sizable special dividends to meet that target. EOG could return $4.8 billion to investors this year at current oil prices.

Meanwhile, with its oil-fueled profits surging, ConocoPhillips recently added $2 billion to its 2022 capital return plan, boosting it up to $10 billion. The company intends to pay that out across three buckets: a base quarterly dividend, share repurchases, and a variable return of cash (VORC). ConocoPhillips has already boosted its VORC twice this year, growing it by 250%.

Many ways to cash in on soaring oil profits

The oil patch has suffered through several lean years over the past decade because there was too much supply. Now the industry is enjoying a resurgence in profits thanks to surging oil prices. Given the sector's uncertain future, companies remain reluctant to boost spending and drill more wells. Instead, they're opting to return their windfall to shareholders by making massive dividend payments. That's enabling their investors to cash in on higher crude prices, helping them offset at least some of the pain their feeling at the pump.