Oil prices have quietly rallied over the past month. The U.S. oil benchmark, West Texas Intermediate (WTI), has surged 15% and recently closed above $80 a barrel for the first time since April.
Crude oil prices could have further to run. Bank of America expects oil to hit $90 a barrel by early next year. While that would hurt consumers, it would be a boon for oil stocks. Here's a look at what's fueling oil prices and some oil stocks to consider buying to cash in on the rally.
The bull case for crude oil prices
Oil has risen by around $10 a barrel over the past month. Several factors have fueled oil's rebound, including additional production cuts by OPEC+ and growing optimism that the global economy could avoid a recession.
Crude prices could continue pushing higher. The combination of OPEC's production cuts and healthy demand growth should drive a widening gap between supply and demand. Analysts at UBS forecast that the shortfall will rise from 700,000 barrels per day (BPD) last month to around 2 million BPD in July and August when Saudi Arabia will lead an extra 1 million BPD in production cuts. The resulting deficit will cause global storage levels to decline, which should push oil prices higher.
In Bank of America's view, "The stars are finally aligning for a run in crude oil prices over the coming quarters." It sees the steady decline in oil-inventory levels likely driving oil to around $90 a barrel early next year.
Cash in on higher crude prices
Higher oil prices would enable producers to generate more cash. That would be a boon for investors because many oil companies plan to return a percentage of their cash flow to shareholders. Thus, as cash flow rises, cash returns would increase.
Devon Energy (DVN 0.19%) is the industry trailblazer in returning cash to shareholders. The oil company established the industry's first fixed-plus-variable dividend framework a few years ago. It pays a fixed dividend each quarter. In addition, Devon pays out up to 50% of its post-base-dividend free cash to investors in variable dividends. The combined dividend payment has ebbed and flowed with oil prices over the past several quarters:
Data source: Devon Energy. NOTE: Chart by the author.
Higher oil prices would give Devon more cash to pay dividends. It would also allow it to repurchase shares. Devon has repurchased $2 billion in shares since late 2021 and recently boosted its authorization by 50% to $3 billion. That's enough to retire 9% of its outstanding shares. Growing cash returns fueled by higher oil prices could enable Devon to produce strong total returns for investors.
Pioneer Natural Resources (PXD -2.28%) has followed Devon Energy's lead in returning a significant percentage of its free cash flow to shareholders. It set a policy to return at least 75% through a combination of the base dividend, share repurchases, and variable-dividend payments. That gives Pioneer the flexibility to opportunistically repurchase shares when it believes they trade at a compelling valuation. That was the case in the first quarter. Pioneer paid less in variable dividends to execute $500 million in share repurchases because its shares declined along with oil prices. It has now repurchased 4% of its outstanding shares since the beginning of last year.
Higher oil prices in the future would give Pioneer more money to return to shareholders. That could allow it to boost its variable-dividend payment while continuing to buy back a meaningful amount of shares. Those increased cash returns could give its shares the fuel to rally.
Diamondback Energy's (FANG 0.32%) capital-return strategy mirrors Pioneer's plan. It also returns 75% of its cash to shareholders through a base dividend, repurchases, and variable dividends. Meanwhile, like its peer, it used its flexibility in Q1 to capitalize on market volatility. During the banking crisis, the oil company spent $332 million to buy back shares. As a result, it only had $6 million left for variable dividends. That worked out to $0.03 per share, which it tacked on to the base payment of $0.80.
While Diamondback had to prioritize how it allocated cash when oil was lower, rising oil prices would give it more money to return to shareholders. It could use that money to buy back even more shares if they traded at an attractive price. If not, it could significantly increase its variable dividend. Either option could help fuel a strong total return for investors.
Many ways to cash in on the rally in crude oil
Oil prices have quietly rallied toward $80 a barrel and could have further upside. Higher prices would boost the cash flow of oil producers. Devon, Diamondback, and Pioneer plan to return a meaningful percentage of that windfall to investors. That could give them the fuel to produce strong total returns if oil continues to rally, making them look like attractive buys right now.
