Oil companies have paid out a gusher of dividends this year. Many companies instituted fixed-plus-variable dividend strategies to return more of their free cash flow to shareholders over the past year. With oil prices topping $100 a barrel earlier this year, it boosted their free cash flow, allowing them to pay increasingly larger dividends.

However, in recent months, oil prices have cooled off on concerns that the economy's heading toward a recession. As a result, oil-fueled variable dividends are falling. Here's a look at whether these falling dividend payments signify that investors should sell their oil stocks.

Variability cuts both ways

Devon Energy (DVN -0.46%) launched the oil industry's fixed-plus-variable dividend framework early last year. The company started with an $0.11 per share quarterly base dividend. It made its first variable dividend payment of $0.19 per share in the first quarter of 2021, paying out a total of $0.30 per share. Devon has since increased its base dividend payment to $0.18 per share while paying a steadily rising variable dividend. At the peak, the combined payment reached $1.55 per share in the second quarter. 

However, Devon's most recent combined dividend payment was $1.35 per share. That lower dividend has weighed on Devon's share price as some investors sold the stock following the dividend reduction.   

Several other oil companies also declared lower variable dividend payments in recent weeks. Pioneer Natural Resources (PXD 0.07%) will pay a fixed-plus-variable dividend of $5.71 per share for the fourth quarter, down from the $8.57 per share it paid out in the third quarter. Diamondback Energy (FANG -0.77%) will pay a base-plus-variable dividend of $2.26 per share for the third quarter, down from a total dividend payment of $3.05 per share in the prior quarter. Meanwhile, ConocoPhillips (COP -0.41%) cut its variable return of cash payment from $1.40 per share in the second quarter to $0.70 per share in the third. 

While investors don't like to see dividend reductions, that's the potential drawback of variable dividends. They ebb and flow with these companies' oil-fueled cash flows. With oil prices falling in the third quarter, their free cash declined, necessitating they pay lower variable dividends.

A cause for concern?

Even though many oil companies reduced their variable dividends in the third quarter, they could continue to pay attractive variable dividends in the future. Some could eventually eclipse their peaks even if oil doesn't return to the triple digits.  

One factor fueling that view is the investments these companies are making to grow their cash flows. For example, Devon Energy used $2.5 billion of the cash it has retained this year to buy two cash-gushing oil properties. Those deals have it on track to grow its cash flow by 25% in the fourth quarter compared to the prior year period, given where oil prices are these days. Diamondback Energy also recently made an acquisition accretive to its free cash flow. In addition to making deals, oil companies continue to invest in drilling new wells and other development projects to maintain and grow their oil and gas production. 

Another factor that could help bolster variable dividend payments in the future is the impact of share repurchase programs. Oil giant ConocoPhillips recently added an enormous $20 billion to its buyback authorization, boosting the total to $45 billion. The additional authorization is enough to retire about 12% of its outstanding shares. With fewer outstanding shares, ConocoPhillips' variable return of cash payment could rise on a per-share basis even if it pays the same amount. 

Devon Energy, Pioneer Natural Resources, and Diamondback Energy are also buying back meaningful amounts of their outstanding shares. Pioneer Natural Resources bought back another $500 million of its stock as the share price declined in the third quarter, bringing its total over the past year to $1.5 billion, or 3% of its outstanding shares. It still has $2.75 billion remaining on its current $4 billion authorization. Devon has repurchased $1.3 billion of stock as part of its $2 billion authorization, reducing its outstanding shares by 4%. Meanwhile, Diamondback Energy doubled its share repurchase authorization to $4 billion earlier this year.

These companies are muting some of the impact oil prices have on their variable dividends by making investments to boost their cash flows and using some of their retained cash to reduce their outstanding shares. They could make higher payments in the future even if oil prices remain around their current level.

Investors need to embrace the variability

Variable dividends, by definition, will vary from quarter to quarter. so, investors should expect them to fall along with oil prices. However, they also offer upside potential. While the main upside driver this year was higher oil prices, acquisitions and share repurchases could help boost variable dividend payments in the future. That makes oil stocks an attractive option for investors willing to embrace their variability in exchange for the income upside potential they offer.