Refining companies are at an interesting crossroads. Demand for refined products is strong these days as the economy gets back on its feet after hitting a speed bump during the early stages of the pandemic. This means the margins they're earning to refine oil into gasoline, diesel, and jet fuel are soaring, giving them gushing profits to pay big-time dividends.
However, instead of investing some of that windfall into expanding their oil refining capacity to make more money in the near term, many refining companies are starting to invest in facilities that produce renewable fuels. They believe this strategy will pay bigger dividends over the long term as the economy switches fuel sources, moving away from fossil fuels to cleaner alternatives.
Switching to a new fuel source
Phillips 66 (PSX -0.66%) has been a great dividend stock since its inception a decade ago. The refining, midstream, and chemicals company has increased its dividend 11 times over the last 10 years, growing its payout at an 18% compound annual rate. It made its most recent increase in May, giving investors a 5% raise. That has helped push its dividend yield up to 4.3%
Over the years, a big driver of dividend growth has been the company's investments to expand its chemicals and midstream business. The company and its joint venture partner Chevron (CVX 0.44%) have steadily expanded the production capacity of CPChem. Meanwhile, Phillips 66 has built new pipelines, processing plants, and export facilities to grow its midstream operations.
However, the conversion of its legacy refining business to renewable fuels could be a big growth driver in the future. Phillips 66 recently approved the conversion of its San Francisco refinery into one of the world's largest renewable fuels facilities. It will invest $850 million in the project, which should start commercial operations in 2024.
Instead of processing crude oil, the facility will use waste oils, fats, greases, and vegetable oil to produce 800 million gallons of renewable transportation fuels per year (about 50,000 barrels per day), including renewable diesel, renewable gasoline, and sustainable aviation fuel. That will help reduce carbon emissions while enabling the company to continue generating income from the facility for years to come in support of its dividend.
The fuel to restart its dividend growth engine
Valero (VLO -0.32%) has also steadily increased its dividend over the last decade. The refiner has grown its dividend payment from $0.65 per share in 2012 to the current level of $3.92 per share, giving it a 3.4% yield. While Valero has kept its payout flat at that $3.92 per share level since 2020, it should have plenty of fuel to grow it in the future.
Valero, already the world's largest independent oil refiner, is building out industry-leading renewable diesel and ethanol businesses. The company is currently the No. 2 producer of those fuels, with 700 million gallons of annual renewable diesel and 1.6 billion gallons of annual ethanol production capacity.
The company expects to complete its latest renewable diesel project by year end. When combined with a project it finished last year and some other refining and logistics projects, Valero expects to generate an incremental $1.2 billion to $1.7 billion of annual earnings before interest, taxes, depreciation, and amortization (EBITDA) from these investments in the future. Meanwhile, it's developing a sustainable aviation fuel and renewable hydrogen, which could drive additional growth. These investments should give it more fuel to grow its dividend in the coming years.
This dividend aristocrat is going green
Chevron's CEO has gone on record to state that he doesn't believe the U.S. will ever build another oil refinery. That's because the industry is already looking ahead to producing the fuels of the future. For example, Chevron is investing $10 billion in lower-carbon energy sources through 2028, including renewable fuels.
The integrated oil giant set an aim to grow its renewable fuels production capacity to 100,000 barrels per day to meet growing customer demand for renewable diesel and sustainable aviation fuel. It has made two deals this year to help achieve that bold goal. It acquired Renewable Energy Group for $3.15 billion in cash and formed a joint venture with Bunge to produce feedstocks for making renewable fuels.
Chevron's push into producing renewable fuels will enable it to steadily pivot its business toward lower-carbon energy. That should allow the company to continue producing a growing cash flow stream to support its steadily rising dividend. Chevron has increased its payout, which currently yields 3.8%, for an impressive 35 straight years, qualifying it as a Dividend Aristocrat.
Switching fuels to keep growing the payout
Phillips 66, Valero, and Chevron cashed in on their ability to turn crude oil into refined petroleum products over the years, giving them the fuel to pay a growing dividend. However, the global economy wants to switch to cleaner fuels in the future to fight climate change. That's leading these refining companies to pivot their businesses to the fuels of the future so that they can continue paying a growing dividend.
