Oil prices had traded in a range of $65 to $80 a barrel for most of this year. However, crude prices have recently broken out of that range, rallying above $85 a barrel. They could have further to run.
This rebound in oil prices will be a boon for oil stocks. It would allow them to produce a lot more cash flow. Devon Energy (DVN 0.19%) and Pioneer Natural Resources (PXD -2.28%) plan to return most of their windfall to investors through variable dividends and share repurchases, and that means oil bulls should buy their shares hand over fist this month.
The bull case for crude prices
Pioneer Natural Resources CEO Scott Sheffield laid out the case for higher crude oil prices on the second-quarter conference call. He pointed out several factors limiting oil supplies in the coming months. The biggest is that under Saudi Arabia's leadership, OPEC has been pulling 1 million barrels per day (BPD) of supply from the market since July. Sheffield expects that group to maintain this cut. Meanwhile, U.S. producers are managing their growth by limiting drilling to produce more free cash. On top of that, the country's emergency stockpile, the Strategic Petroleum Reserve, is at a 40-year low, limiting the country's ability to add supplies to the market.
On the other side of things, oil demand remains resilient. The U.S. economy hasn't slowed down as many expected. On top of that, China has taken steps to jump-start its economy. These factors should keep demand from falling.
With demand remaining strong and supplies limited, global consumption is on track to outpace output in the second half, which will drain inventory levels. Sheffield believes this outlook is "supportive for oil pricing in the $80 to $100 range for the remainder of '23 and through '24 on."
The cash flow gusher
Pioneer can produce a boatload of free cash flow in that oil price range:
Image source: Pioneer Natural Resources.
That would give it a lot of money to return to shareholders. The company intends to return at least 75% of its free cash flow to investors across the following three buckets:
- A strong and growing base dividend: Pioneer has increased its base dividend for six straight years, including by 14% in 2023. At $5.00 per share, the oil company offers an above-average dividend yield of 2.1%.
- Opportunistic share repurchases: Pioneer has repurchased $2.1 billion in stock since initiating the program in January 2022, reducing its outstanding shares by about 4%. It recently authorized a new $4 billion program, enough to retire 7% of its outstanding shares at its current market cap of $56 billion.
- Variable dividends: The company will pay an additional variable dividend each quarter to reach its 75% payout target. It paid an extra $0.59 per share in the third quarter, putting its total dividend payment at $1.84 per share (a 3.1% annualized yield).
The company's combination of meaningful share repurchases and attractive dividend income could give it the fuel to produce strong total returns in the coming quarters.
A trio of catalysts
Higher oil prices would provide a triple benefit for Devon Energy. The company would produce more cash from its existing wells.
On top of that, Devon is drilling more wells to increase its oil output. Devon's oil output reached an all-time high of 323,000 BPD during the second quarter, up 8% year-over-year, fueled by acquisitions and newly drilled wells. The company's drilling program has it on track to continue increasing its output. It sees production rising to as much as 330,000 BPD in the third quarter.
Meanwhile, Devon is starting to capture cost deflation. Lower oil and gas prices have caused natural gas-focused drillers and private producers to pull back on drilling new wells, and now service companies have excess capacity. That's allowing Devon to lock in lower service rates as contracts come up for renewal. Lower service costs will enable the company to drill the same number of wells for less money, freeing up cash.
The combination of higher prices, higher production, and lower costs should enable Devon Energy to produce a lot more free cash flow in the coming quarters. It aims to return half that money to shareholders through dividends (a strong and growing base dividend and a quarterly variable dividend). While its total dividend outlay has fallen in recent quarters, it could rocket in 2024. In addition, Devon will opportunistically repurchase shares. Those higher capital returns could give Devon the fuel to produce strong total shareholder returns.
A potentially great time to buy oil stocks
Oil prices appear poised to trade in a much higher range in the coming quarters. That would enable oil companies to produce significantly more cash. Pioneer and Devon plan to return the bulk of that windfall to shareholders. They look like compelling oil stocks to buy hand over fist this September.
