Oil prices have been rising steadily in recent months. Thanks to support from OPEC, the US oil benchmark, WTI, recently hit $ 57 a barrel, its highest level since last January. In the meantime, oil could have more room to operate, as demand is just beginning to recover and American producers are preaching restraint.
Oil producers are starting to profit after spending much of last year cutting costs. One of the best positioned oil stocks because the current environment is Devon Energy (NYSE: DVN), becoming one of the main purchases now.
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Positioned to thrive with lower oil prices
Devon Energy worked hard last year to reduce its costs so that it could operate at lower oil prices. The company sold higher-cost assets and used cash to pay off debt, reducing its interest expense. These measures led to a sustainable cash cost savings of $ 300 million by the end of last year.
Since then, the company has taken its cost reduction initiatives to another level, agreeing to a peer-to-peer transaction with WPX Energy. The deal will allow it to increase its cost savings to $ 575 million by the end of this year. Devon only needs oil at an average of $ 33 a barrel in 2021 to generate money to drill new wells enough to maintain its current production level. Add that to a strengthened balance sheet thanks to your debt reduction plan, and Devon can thrive on lower oil prices. You can cover your capital program and 2.5% –yielding dividend with plenty of space with oil for less than $ 40 this year.
The strategy is about to pay big dividends
With oil prices currently well above the level Devon needs to maintain its current operations, it is on track to generate significant cash surplus. For example, at $ 50 WTI, Devon could produce more than $ 1.25 billion in free cash, with that number rising to more than $ 2 billion if crude oil averaged $ 60 this year. That’s a lot of money for an oil company that currently has $ 12 billion market value.
Devon has a range of options for that money. It could use the funds to pay more debt, drill additional wells to increase production, or return them to shareholders through dividends and share buybacks. Since Devon already has $ 2.1 billion in cash on its balance sheet, it has the funds necessary to meet its goal of reducing debt by $ 1.5 billion in the short term. In the meantime, the company does not seem likely to increase its drilling program anytime soon. The oil market does not need any new supplies due to the current headwinds of demand and the fact that OPEC is withholding production to sustain prices. Thus, it seems more likely that Devon will return most of the free cash flow it produces this year to shareholders.
The main method will be the variable dividend program, which the company plans to implement this year, now that it has closed its merger with WPX Energy. This strategy will make the company pay up to 50% of its excess free cash each quarter, provided it has a cash balance of more than $ 500 million, a solid balance sheet and a constructive perspective on commodity prices. Since the company currently meets these criteria, it should start making these incremental payments soon. These additional dividends may be substantially higher than the base payment, considering the amount of excess cash that the company appears destined to produce this year.
An ideal way to profit from higher oil prices
Devon Energy’s strategy of becoming an ultra-low-cost oil producer is beginning to bear fruit. It is on track to produce a huge amount of surplus cash this year, thanks to the recent improvement in oil prices. While not the only oil stock to benefit from this recovery, it stands out among its rivals because it plans to send a portion of its unexpected earnings to shareholders through its variable dividend program. This ability to immediately reap the rewards of higher oil prices is why Devon is at the top of my list as the best oil stock to buy right now.