Down Debt

The trend of energy dividends continues. Not everyone is on board.

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An oil pump

Frédéric J. Brown / AFP via Getty Images

Oil companies are pumping more money than they have in years, and the question now is what to do with it.

Most have paid off debts, some of which accumulated at the height of the pandemic when oil prices fell below the cost of production. But with oil prices now above $ 80 a barrel, there is enough liquidity to pay off the debt and return some of it to shareholders. Increasingly, oil companies are choosing a unique way to do it: pay variable dividends based on the amount of cash flow they produce. In good times, the strategy can lead to dividend yields close to 10%.

Variable dividends are one way to solve a thorny problem for oil companies. Before variable dividends, oil companies faced a dilemma. When oil prices were high, it made sense to send more money to shareholders as a dividend. But once a business increases its dividend, it feels compelled to keep the payout the same in good times and in bad times.

When oil prices fall, the dividend can turn into an albatross. This is what happened to

Exxon Mobil

(ticker: XOM) last year – the company’s quarterly dividend payment was so large that many analysts argued that it was better for the long-term future of the company to reduce it. After getting into debt and preserving liquidity through extraordinary measures such as the suspension of certain employee benefits, Exxon was able to preserve the dividend and recently increased it. But other companies like


(BP) has chosen to reduce its dividends, causing the price of its shares to fall sharply.

Variable dividends allow companies to pay large dividends to shareholders when times are good. When oil prices fall, they can reduce the size of the variable dividend while paying a modest base dividend.

The two companies that were the first supporters of variable dividends are shale producers

Devon Energy

(DVN) and

Pioneer of natural resources

(PXD). Devon reported earnings Tuesday night and said its more variable fixed dividend was 71% higher than a quarter ago, at 84 cents per share. At the current share price, that would give the company a dividend yield of 7.9% on an annualized basis. The best may yet be yet to come: Devon says its 2022 dividend could be more than 90% higher than its 2021 payout. CEO Richard Muncrief said during the company’s earnings call that “our policy dividend gives us the flexibility to return even more money to shareholders than any other company in the entire S&P 500 Index ”.

Devon is also finding other uses for the excess cash, announcing a billion dollar share buyback program. Pioneer announces its profits after the market closes on Wednesday.

Muncrief argues that variable dividend policies will make the entire industry more attractive to investors. He says he’s encouraged by “a growing number of other peers who have chosen to prioritize higher dividend payouts.” These disciplined actions will further strengthen the investment thesis for our industry, paving the way for higher fund flows as investors rediscover the compelling value proposition of the E&P space.

Other companies discussing or announcing variable dividends include

Diamondback Energy

(FANG) and

Comstock Resources

(CRK). Diamondback plans to “use redemptions and variable dividends interchangeably depending on which one presents the best return for our shareholders at that time.” Comstock CEO Miles Allison raised the possibility of adding a variable dividend in the future as well.

But not everyone agrees with the strategy. Large diversified oil companies like Exxon and


(CLC) already have significant core dividends. They would likely have to reduce these dividends to change their policy and pay a more variable fixed dividend. Any reduction would likely be seen as a sign of weakness and unlikely to happen in the short term. “We will keep an open mind, but we do not see the value of it,” said


CFO Pierre Breber on a earnings conference call in April.

Some other companies just don’t like the concept of a variable dividend.

Magnolia Oil and Gas

(MGY) CEO Stephen Chazen dismissed the concept during the company’s earnings call on Tuesday, saying he believes investors appreciate fixed and predictable dividends based on the company’s earnings and not on their cash flow. If the company has excess cash, it would prefer to pay a one-time special dividend.

In a previous call, he said the variable dividend does not meet the primary purpose of dividends: “We are trying to convey information about the strength of the company at oil prices low enough that we can afford. to do is the point of the dividend.

Truist analyst Neal Dingmann wrote in an email that the industry appears to be divided on the concept, with around a third of CEOs supporting Chazen’s position. Dingmann wrote that he had recently spoken to an executive who argued that a variable dividend has “the same perceived problems as a buyout. When oil goes down, the variable will go down and this company will have less cash at the bottom of the cycle. “

Despite these arguments, more companies could follow Devon’s lead for one simple reason: Its stock is up 165% this year, about twice the larger group of energy producers. So far, investors are voting with their dollars.

Write to Avi Salzman at [email protected]

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