Occidental Petroleum (OXY -0.09%) has finally gotten back on track this year, largely thanks to surging oil prices. The company produced a record $4.2 billion of free cash flow in the second quarter. That enabled the oil giant to pay off more debt, positioning it to start returning more cash to shareholders.

The company expects to send a significant amount of cash to its investors over the coming years through share repurchases and a rapidly rising dividend. That will make it a more compelling option for dividend-focused investors.

A monster raise with more to come

Occidental Petroleum has been working hard to reduce debt following its acquisition of Anadarko Petroleum in 2019. It sold assets, slashed its dividend payment, and suspended its share repurchase program to allocate more cash toward debt reduction. The company set a goal to pay off another $5 billion of debt this year.

It blew past that target, paying off over $8 billion by the second quarter. That enabled Occidental to start returning more cash to shareholders above its paltry $0.01 per share quarterly dividend. It gave investors an enormous 1,200% raise, boosting the payout to $0.13 per share each quarter, and initiated a $3 billion share repurchase program.

That's only the beginning of the company's capital return plans. CEO Vicki Hollub outlined them on the second-quarter conference call. She noted the company's near-term priorities are to complete its current share repurchase authorization -- it bought back $1.1 billion of shares in the second quarter -- and reduce gross debt to the high teens by year-end. That will reduce its shares outstanding and interest payments, enhancing "the sustainability of our dividend and position us to increase our common dividend at the appropriate time," according to Hollub.

Drilling down into the capital return plans

Hollub gave some insight into the company's dividend growth plans. She stated, "we expect future dividend increases to be gradual and meaningful." Though she cautioned that "we do not anticipate the dividend returning to its prior peak." That still leaves a lot of room to grow, given the wide gap between its current quarterly rate of $0.13 per share and the prior peak of $0.79 per share. 

Overall, Occidental Petroleum believes it could return as much as $4 per share in cash to shareholders next year through dividends and share repurchases. It could send even more than that if oil prices remain elevated. However, it would have to start redeeming the preferred equity owned by Warren Buffett's Berkshire Hathaway (BRK.A -0.28%) (BRK.B -0.68%) to return additional cash to shareholders above that $4 per share level. Berkshire made a $10 billion preferred stock investment in Occidental to help it fund the Anadarko Petroleum deal. Berkshire is also the company's largest shareholder, owning 20% of its outstanding stock, valued at over $11 billion, and warrants to buy another $5 billion in stock. 

A large portion of that incremental return will likely come through share repurchases in the near term because Occidental Petroleum wants to pay a dividend it can sustain at $40 oil next year. However, it will have more capacity to increase the payout as it retires more debt, buybacks shares, and redeems Buffett's preferred equity investment. 

Steady and sizable dividend growth ahead

This year's monster dividend increase is only the beginning. While the oil company doesn't anticipate its dividend will return to its peak, it still expects to gradually give investors meaningful raises, with its ability to pay dividends rising as it retires debt, shares, and Buffett's preferred equity. It could become a much more compelling dividend stock over the next few years.