Higher oil prices this year are giving oil companies the fuel to produce record cash flows. In times past, the industry used its windfall from higher oil prices to drill more wells and boost production. However, they've been reluctant to do that this year, having been burned in the past since higher production eventually sent prices lower.
While oil prices could go higher in 2023, giving oil stocks the fuel to continue growing their cash flow, the industry isn't banking on that outcome. Instead, many companies are using some of their oil-fueled cash flow to make acquisitions and drive growth in the coming year.
Acquiring two cash flow machines
Devon Energy (DVN -0.20%) has been a trailblazer in the oil industry over the past few years. It launched the sector's first fixed-plus-variable dividend framework, following its merger of equals with WPX Energy last year. That strategy has Devon paying a fixed quarterly dividend that it can sustain at lower oil prices and steadily increase. It also pays out up to 50% of its post-base-dividend free cash flow to shareholders each quarter via a variable dividend.
Surging oil prices have enabled Devon to pay out sizable variable dividends this year. It's also given the company the money to acquire two cash-gushing oil properties. Devon paid $2.5 billion in cash to buy Validus Energy and RimRock Oil & Gas to boost its positions in the Eagle Ford shale and Williston Basin, respectively. Those deals will grow its oil and gas production and its cash flow.
With those acquisitions now closed, Devon expects its fourth-quarter production to be 6% above its year-ago total, while free cash flow will surge 25%. That's giving Devon the fuel to boost its base dividend, and should support higher variable dividends in the future.
Following the leader
Diamondback Energy (FANG -0.21%) has followed the path laid out by Devon, with some variations. It has instituted a fixed-plus-variable dividend strategy to return up to 75% of its free cash flow to shareholders. The company includes share repurchases as part of that return.
Diamondback has also followed Devon's acquisition blueprint; it has agreed to acquire FireBird Energy and Lario Permian for a combined $3.3 billion in cash and stock. The deals will add an estimated 50,000 barrels of oil equivalent per day (BOE/D) to Diamondback's production in the Permian Basin, a meaningful amount for a company that produced 390,600 BOE/D in the third quarter.
Meanwhile, those deals should generate an incremental $570 million in free cash flow next year. That's a sizable proportion of the more than $4 billion in free cash the company expects to generate this year. And it will give Diamondback more money to return to shareholders as part of its capital return framework.
Adding more fuel to boost the dividend
Marathon Oil (MRO -0.83%) has generated a gusher of cash flow this year, fueled by higher oil prices. It's on track to produce over $4 billion in free cash flow.
The oil producer is sending a sizable portion of that money to shareholders. It returned a record $1.2 billion to investors in the third quarter via a steadily rising base dividend and share repurchase program. Marathon increased its dividend payment by 13% in the third quarter and boosted it in six of the last seven quarters, growing it by 200% since the start of last year. Meanwhile, it has used the cash it retained to maintain a strong balance sheet.
The company is using its financial flexibility to acquire the Eagle Ford assets of Ensign Natural Resources for $3 billion. It's a highly strategic and financially accretive acquisition that will add 67,000 BOE/D of production to Marathon's total, a meaningful uplift for a company that produced 352,000 BOE/D in the third quarter.
The deal will also boost Marathon's free cash flow by 15%, allowing it to expand its cash distributions to shareholders by 17%, including a plan to increase the dividend by another 11%. It also includes a sizable inventory of drilling and potential redevelopment locations that could allow the company to expand output in the future.
Wheeling and dealing to drive additional growth
Oil companies have been reluctant to use their oil-fueled cash flows to drill additional wells that increase their output, given all the uncertainty in the oil market and the economy. Instead, they've been returning more cash to shareholders, and using their improving financial position to acquire assets that boost their production and cash flow. That should enable them to continue growing in 2023 even if oil and gas prices remain flat. This catalyst would give them more fuel to return additional cash to shareholders in the coming year, and to grow shareholder value.