Crude oil prices have gotten off to a roaring start in 2023. West Texas Intermediate, the primary U.S. oil price benchmark, has risen from around $70 a barrel at the beginning of the year to more than $85 a barrel this month. Several factors have fueled oil prices, including growing tensions in the Middle East. Oil could soar even higher if those tensions boil over into a regional war.
Rising oil prices will benefit oil companies. They should produce more free cash flow, giving them more money to return to investors. While higher prices should provide a boost to most oil stocks, Devon Energy (DVN 0.70%), Diamondback Energy (FANG -0.92%), and ConocoPhillips (COP -0.01%) stand out as three of the top ways to cash in as crude prices rise.
An oil-fueled dividend
Devon Energy offers investors one of the best ways to cash in on higher oil prices. The oil company pays an innovative fixed-plus-variable dividend. It pays a base dividend each quarter of $0.22 per share, which it recently increased by 10%. That payout gives it a 1.7% dividend yield at the recent share price, which is above the S&P 500's 1.4% dividend yield.
On top of that, Devon pays a variable dividend with a portion of its excess free cash flow. That payout has varied over the years, rising and falling with its oil-fueled cash flows:
Data source: Devon Energy. Chart by the author.
As that chart shows, Devon's last combined dividend payment was $0.44 per share. That put its annualized dividend yield at 3.3%. Given this year's rise in oil prices, Devon could pay higher variable dividends in the coming quarters.
In addition to paying dividends, Devon plans to use more of its oil-fueled free cash flow to buy back its dirt cheap shares. Those shareholder returns, combined with rising free cash flow and higher oil prices, could give Devon the fuel to produce strong total returns.
A needle-moving deal could prove to be an even bigger catalyst
Diamondback Energy has followed Devon Energy's playbook. The oil company also pays a growing fixed quarterly dividend that it supplements with variable dividends and share repurchases:
Image source: Diamondback Energy.
As that slide shows, Diamondback Energy has grown its base dividend at a brisk 9.2% compound quarterly rate. The company has delivered industry-leading dividend growth since it initiated the payout in 2018. It currently offers a similarly above-average dividend yield of 1.7% on its base payout.
Meanwhile, the company routinely pays a variable dividend. It most recently paid $2.18 per share in addition to its $0.90-per-share base quarterly rate (a 7% increase from the prior level). That pushed its annualized yield up to 6% at the recent share price.
Diamondback Energy recently took a big step to enhance its ability to cash in on higher oil prices. It's buying rival Endeavor Energy Resources in a $26 billion deal to create a premier producer focused on the prolific Permian Basin. The company expects the deal will boost its free cash flow per share by 10% next year, assuming flat oil prices. Higher oil prices would make that deal even more accretive. That would enable the company to produce even more free cash flow that it could return to shareholders through dividends (base and variable) and its meaningful share repurchase program.
The potential to boost its return of capital program
ConocoPhillips sets a capital return target each year that it adjusts based on market conditions. Last year, it planned to return $11 billion in cash to shareholders through its three-tier framework of paying ordinary quarterly dividends, making quarterly variable return of cash (VROC) payments, and repurchasing shares. It achieved that target, paying $5.6 billion in dividends and VROCs while purchasing $5.4 billion in shares.
The oil company initially set a lower return of capital target of $9 billion this year because of lower oil prices at the onset of 2023. While the company planned to reduce the overall return, it boosted its ordinary quarterly dividend by 14% late last year. Instead, the reduction would come by paying a lower VROC (it declared $0.58 per share in the first quarter compared to $0.60 per share in the year-ago period) and repurchasing fewer shares.
However, stronger oil prices could give ConocoPhillips the cash flow and confidence to increase its return of capital target this year. The company did that in 2022, when oil prices surged. It initially set a target of returning $7 billion to shareholders but ended up sending them $15 billion through higher VORC payments and share repurchases.
These oil stocks will send investors a portion of their oil-fueled cash flows
Higher oil prices will enable oil companies to produce more free cash flow this year. Many return a portion of their excess earnings to investors via dividends and share repurchases. Devon, Diamondback, and ConocoPhillips stand out because they typically ramp up their cash returns when prices rise by paying higher variable dividends. Their investors stand to cash in if crude prices continue rising this year.
