U.S. benchmark West Texas Intermediate (WTI) crude oil prices topped $80 per barrel on Jan. 15 after closing out 2024 closer to $70 per barrel. Geopolitical policy is driving higher prices.
On Jan. 10, the U.S. hit Russia with strict sanctions, driving up prices. To quote a press release by the U.S. Department of State: "The United States is imposing sanctions today on more than 200 entities and individuals involved in Russia's energy sector and identifying more than 180 vessels as blocked property. This wide-ranging, robust action will further constrain revenues from Russia's energy resources and degrade [Russian President Vladimir] Putin's ability to fund his illegal war against Ukraine."
Assuming consistent demand, higher oil prices can increase oil companies' profits. But if demand falls due to an economic slowdown, it can erode some benefits of higher profit margins.
As the two largest U.S. oil and gas companies by market capitalization, ExxonMobil(NYSE: XOM) and Chevron(NYSE: CVX) are natural choices for investors looking for dividend stocks in the oil patch. But that doesn't necessarily mean these two majors will benefit the most from higher oil prices.
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Consistency you can count on
ExxonMobil and Chevron have geographically diverse global production assets with sizable refining segments and low-carbon ventures. They also have rock-solid balance sheets and decades of dividend increases -- 42 consecutive years for ExxonMobil and 37 years for Chevron.
In December, ExxonMobil updated its corporate plan, including new cost savings targets, earnings and cash-flow expectations, capital return program goals, and more through 2030. By defining clear objectives over five years, ExxonMobil is holding itself accountable and painting a big picture for long-term investors to look past quarterly results.
Similarly, Chevron expects to deliver further structural cost savings of $2 billion to $3 billion by 2026 while maintaining a low-cost, high-margin production portfolio.
Exxon and Chevron are avoiding overexpansion, which would leave them more vulnerable during a downturn. So investors shouldn't expect either company to aggressively ramp up spending just because oil prices are going up. Rather, the focus is to turn a profit even during periods of mediocre oil prices to support capital expenditures and dividend increases.
In its latest corporate plan update, ExxonMobil charted a path toward a breakeven level of $30 per barrel Brent (the international benchmark) by 2030. Through 2030, it expects to generate $110 billion in surplus cash at $55 per barrel Brent and $280 billion in surplus cash at $85 per barrel Brent. The key is to leave room for upside potential without betting the farm on oil prices going up.
Since both companies are focused more on production quality than quantity, the bulk of excess profits would probably go toward higher stock buybacks.mChevron sports a slightly higher dividend yield of 4.1% compared to 3.6% for ExxonMobil, but both companies can be excellent passive income sources and foundational energy stocks to buy now.
Higher risk, higher potential reward
The greatest beneficiaries of higher oil prices are leveraged companies or companies with higher breakeven levels. Higher oil prices have a way of making even low-quality businesses look attractive. However, only the best businesses can do well when the tide goes out during periods of lower oil prices.
Occidental Petroleum(NYSE: OXY), Diamondback Energy(NASDAQ: FANG), and Devon Energy(NYSE: DVN) aren't bad businesses, but they are pure-play exploration and production (E&P) companies that all made splashy acquisitions in 2024. These acquisitions can help all three companies produce outsize free cash flow when oil prices are high. However, they can also leave balance sheets strained when oil prices are low.
As you can see in the following chart, Occidental Petroleum, Devon Energy, and Diamondback Energy have far higher financial debt-to-equity leverage ratios than ExxonMobil and Chevron -- showcasing how the capital structure of these E&Ps is more dependent on debt.
Each E&P pays a dividend, but they aren't nearly as reliable as ExxonMobil and Chevron. Occidental Petroleum slashed its quarterly payout to just $0.01 per share in 2020. Diamondback and Devon have historically paid variable dividends that fluctuate based on the business's underlying performance, making them inconsistent options for investors looking for a predictable passive income stream.
However, E&Ps can outperform the majors and the energy sector when oil prices are going up. For example, Devon Energy is up 17.4% year to date at the time of this writing compared to an 8.8% gain for the energy sector.
Maintain a long-term view with the energy sector
Before investing in the energy sector, it is important to understand how different industries within the sector respond to oil prices and each company's risk/potential reward profile.
ExxonMobil and Chevron may not boom to the same extent as leveraged E&Ps when prices are rising, but they also have raised their dividends even during brutal industrywide slowdowns. Both provide a good starting point for investors who are new to the sector and are seeking foundational holdings, whereas most E&Ps are riskier but also have higher potential rewards.
If you're still looking for an E&P to buy now, consider ConocoPhillips(NYSE: COP). It is arguably the highest-quality company in the industry, has a low cost of production, and has a path for dividend growth.
Long-term investors should focus more on the companies that have what it takes to perform well no matter the cycle rather than trying to make a quick buck by betting on the riskiest names during an upswing in oil prices.
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Daniel Foelber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Chevron. The Motley Fool recommends Occidental Petroleum. The Motley Fool has a disclosure policy.
