Oil prices have been incredibly volatile this year. West Texas Intermediate (WTI), the primary U.S. oil price benchmark, started 2022 at around $75 a barrel before surging to more than $120 a barrel following Russia's invasion of Ukraine. While crude prices have cooled off since then on fears that a recession will cut into oil demand, WTI is currently hovering close to $90 a barrel, putting it up more than 15% on the year.
With all eyes on a possible recession, the market is missing the fact that oil supplies remain stressed. Oil field service companies are facing persistent equipment shortages, which are holding back the industry's ability to drill more wells. This shortage could further constrain supplies. Because of that, some analysts forecast that crude prices will rebound to $120 a barrel. That would send oil stocks soaring while giving companies more cash to pay dividends.
Drilling down into the problem
It takes a lot of equipment, personnel, and supplies to drill and complete an oil well. Oilfield service companies like Halliburton (HAL -0.92%) and Baker Hughes (BKR -0.43%) utilize powerful truck-mounted engines known as frack pumps to fracture underground rock formations, allowing oil and gas to flow out through the well. This equipment endures a lot of wear and tear. Because of that, companiess need to steadily replenish their fleet by investing in new equipment.
However, with the oil price downturns of 2020 and 2014 burned into their memories, oilfield service companies are reluctant to spend the money needed to refresh their fleets. Instead, they're opting to recondition existing equipment as they try to maintain capacity. Unfortunately, there's not enough equipment to meet the demand these days. Add in shortages for steel pipes and the crews needed to operate this equipment, and there are serious questions about whether the U.S. oil industry can meet its production forecasts.
That would put even more pressure on supplies. Because of that, oil prices could soar even if demand starts to fall as consumers pull back in a recession.
Cashing in on equipment demand
Halliburton is one of the big beneficiaries of the strong market for oilfield services. CEO Jeff Miller stated in the company's second-quarter earnings report that the North American fracking market is "all but sold-out." Because of that, Miller expects Halliburton to "deliver profitable growth, margin expansion, strong free cash flow, and industry-leading returns in this upcycle."
The company is using its free cash flow to repay debt, retiring about $600 million this year. It also nearly tripled its dividend. Halliburton expects to continue growing distributions to shareholders as it generates more cash through a higher dividend and likely a share-repurchase program.
Baker Hughes also expects to capitalize on the strong environment for oilfield services. It sees cash flow rising, giving it the money to invest in new equipment and its energy transition initiatives. Even with those investments, it expects to return 60% to 80% of its free cash flow to shareholders. That likely means the company will eventually boost its dividend to complement its ongoing share-repurchase program.
Cashing in on crude
Another impact of the sold-out North American fracking equipment market is that it's limiting the ability of U.S. producers to expand their output. Since they can't spend their oil-fueled windfalls on drilling more wells, many are using that cash to pay dividends and repurchase shares. Those payouts have surged this year and could keep rising if crude prices rally again.
Oil driller Diamondback Energy (FANG 0.92%) recently boosted its capital-return program from 50% of its free cash flow to 75%. Diamondback increased its base dividend by another 7.1%, declared its second variable-dividend payment, and doubled its share-repurchase authorization. The combined-dividend payment at its recent share price implied an annualized dividend yield of around 10%. Meanwhile, the repurchases should provide a further boost to the stock, which is already up over 20% this year.
Fellow oil producer Pioneer Natural Resources (PXD 1.18%) has increased its base-dividend payment by 40% this year. It has also paid out sizable variable dividends, targeting to pay out 75% of its free cash flow each quarter. Its most recent combined-dividend payment had an implied annualized dividend yield of around 15%, the highest in the oil patch. It's using most of the remaining balance to repurchase shares, helping fuel its stock price, which has already rallied more than 30% this year.
More and more oil companies are opting for variable-dividend structures to return some of their oil-fueled windfalls to shareholders. Because of that, investors can immediately cash in as oil prices rise.
No shortage of cash
The oil industry doesn't have enough equipment to meet demand. Because of that, service companies are cashing in on higher prices, enabling them to generate more cash to return to their shareholders. Meanwhile, since oil producers can't increase capital spending, they're returning their windfall to investors. With market conditions unlikely to improve anytime soon, oil stock prices and dividend payments appear poised to continue heading higher.
