Oil and natural gas prices are volatile and the ups and downs will drive the financial results of companies like Pioneer Natural Resources (PXD -2.28%) and Devon Energy (DVN 0.19%). These drillers can't control that fact of their business, but there is another aspect of the operations of these U.S. drillers that is within each company's control. And Pioneer comes out on top.
A variable business
Pioneer and Devon are energy drillers that have garnered a lot of attention of late because of their high dividend yields. Pioneer's stock yields around 11% today, while Devon's yield is roughly 9%. Those are very large numbers, given the average energy stock's yield is closer to 4%, using Vanguard Energy Index ETF as a proxy.
The reason their dividends are so high is because they have both adopted a variable dividend policy. Essentially, they have a base dividend that management at each company believes is sustainable. On top of that, both companies layer in a dividend that rises and falls along with financial performance. Since financial results for each of these energy companies are directly tied to oil and natural gas prices, total dividends also rise and fall along with energy prices.
This isn't necessarily a good or bad thing, it is just a different way for a company to reward shareholders. Investors get an extra boost, via dividend increases, when times are good but are expected to share in the pain when times are bad, via dividend reductions. This might be attractive to an investor who wants to protect themselves from everyday energy expenses like gasoline and heating. Right when you would be facing higher costs as a consumer, you would likely be collecting a larger dividend as an investor.
There's another number in play here, however, that separates these two drillers.
How much longer can you drill?
While oil and natural gas are commodities, wells are depleting assets. Once you pull a barrel of oil out of the ground and consume it, that well will run dry, eventually. Which is why investors need to look past today's production and examine the prospects for future production. Not to put too fine a point on it, if an energy company doesn't continue to drill new wells, it will eventually run out of oil and will have to close up shop.
When you compare Pioneer and Devon Energy, which both focus on the U.S. onshore market, you want to get a handle on their future well opportunities. Pioneer estimates that it has a little more than 20 years worth of well inventory to drill. Devon Energy pegs its well inventory at roughly 12 years.
There are caveats. Commodity prices come into play, since higher prices will make more potential wells profitable to drill, and vice versa. There's also the matter of how many wells get drilled in any given period, since an increased drill rate would run through the potential inventory of wells more quickly. Acquisitions, which are impossible to predict, can also change the math very quickly. So these numbers are really just a point in time, but they do give an important read on the future.
PXD Debt to Equity Ratio data by YCharts.
And that read is that Pioneer has a lot more years of drilling ahead of it than Devon. That in and of itself doesn't make Pioneer a better investment. However, when you add in the higher yield (noting that yield is transitory here) and a lower degree of leverage (which has been a fairly consistent trend of late), the positives start to add up.
Just enough to tip the balance
If you are looking at Devon Energy and Pioneer as investment options in the energy sector, they clearly have important similarities. But it is the subtle differences that will help you make a selection between the two. For more conservative investors, Pioneer will likely come out ahead thanks, at least in part, to a longer pipeline of drilling opportunities.
