Pioneer Natural Resources (PXD -2.28%) believes the weakness in oil prices over the past year is about to end. The oil company anticipates that a cascade of catalysts will support higher crude prices through the end of this year and beyond. That sets the oil company up to produce a gusher of free cash flow.
Here's a look at what's driving the oil company's bullish view on crude prices and what that could mean for investors.
The bull case for higher oil prices
Pioneer Natural Resources CEO Scott Sheffield recently provided a broad overview of the current oil market and its impact on prices on the company's second-quarter conference call. Sheffield pointed out that "crude has been range bound between $65 and $80 over the past several months." He noted that several factors have weighed on oil, including releases from the Strategic Petroleum Reserve (SPR), recessionary concerns, and weak economic data from China.
However, that weakness has reversed over the past couple of months, pushing oil up toward the $80-a-barrel level. The driver is the expectation that supply and demand fundamentals will tighten in the second half of this year. Sheffield pointed out that there's growing optimism that the U.S. economy could experience a soft landing while China has taken steps to boost its economy. These factors bode well for demand to remain strong.
Meanwhile, Sheffield highlighted that supplies are growing tighter. U.S. oil producers continue to limit drilling to produce free cash. On top of that, the SPR is at a 40-year low, restricting the country's ability to release additional supplies in an emergency. Finally, Saudi Arabia continues to keep a lid on OPEC's production. Sheffield said he expects "Saudi to extend their 1 million-barrel-a-day cut they initiated July 1 toward the end of '23."
This combination of factors drives his view that demand will outpace supplies during the second half of this year, drawing down global-inventory levels. This outlook is "supportive for oil pricing in the $80 to $100 range for the remainder of '23 and through '24 on."
Positioned to cash in on higher crude prices
Higher oil prices would be a boon for Pioneer Natural Resources. The company's concentrated position in the Midland side of the Permian Basin gives it tremendous scale. Because of that, it has very low operating costs, enabling it to produce peer-leading margins.
That combination of scale and margins would enable Pioneer Natural Resources to produce a massive amount of cash in the $80 to $100 a barrel range:
Image source: Pioneer Natural Resources.
As that slide shows, Pioneer could produce $27 billion in free cash flow over the next five years if oil averages $80 a barrel, more than double what it could produce at $60 crude. Meanwhile, free cash flow would reach $40 billion if oil averaged $100 a barrel. To put that into perspective, Pioneer's current market cap is less than $55 billion. It suggests the company could produce more than half its market cap in free cash flow in just the next five years.
Pioneer Natural Resources expects to return most of this windfall to shareholders. The oil company set a framework to return at least 75% of its free cash flow to investors each year. It has three methods to accomplish that aim:
- Base dividend: Pioneer plans to pay a strong and growing base dividend. It currently pays an annual rate of $5 per share (a 2.1% dividend yield at the recent share price). It has increased its base payment in each of the last six years.
- Share repurchases: The company opportunistically repurchases shares with excess free cash. It bought back $124 million shares in Q2 and over $2 billion since it started the program in 2022 (over 4% of its outstanding shares).
- Variable dividends: The oil company will also return additional cash to investors through variable dividends. It paid an additional $0.59 per-share variable dividend in Q2, boosting its annualized yield to over 3%.
With its free cash flow likely to be even higher in the future, Pioneer will have more cash to opportunistically repurchase shares and pay variable dividends.
A potentially high-return oil stock
Pioneer Natural Resources expects oil prices to be higher in the coming years. That sets the oil company up to produce a massive amount of free cash flow, the bulk of which it intends to return to shareholders. Those growing cash returns could give the company the fuel to produce strong total returns in the coming years. That makes Pioneer a potentially attractive oil stock to buy for those who are also bullish on oil prices.
