Oil markets have experienced significant volatility in recent years, with prices per barrel dropping below $25 in 2020 and exceeding $100 two years later. Currently, oil prices are around $70 per barrel. For those seeking oil stocks that can perform well in fluctuating market conditions, Chevron and Occidental Petroleum are notable options.
Superior Capital Allocation
Effective capital allocation within the oil industry is crucial, as companies often prioritize survival over shareholder profits. Occasionally, a company might profit substantially from a particular reservoir, generating significant free cash flow over the well’s lifespan. Ideally, this free cash flow would be redistributed to investors. However, management sometimes diverts these funds into acquiring new assets, which may not provide the same returns, potentially squandering the original profit source.
Capital allocation plays a vital role in identifying profitable oil stocks. Indicators such as return on equity (ROE) measure how well a company generates earnings for its shareholders, while return on invested capital (ROIC) assesses value creation for both debt and equity holders. Chevron, a prominent oil brand, scores well in terms of long-term average ROE and ROIC, consistently reaching double digits.
Despite some challenges, Chevron has demonstrated resilience, supported by its financial strength and long-term strategy. Its stock remains reasonably priced, trading at 15 times earnings—approximately half of the market average—and offering a free cash flow yield above 6%. This strong track record and shareholder-friendly approach have even attracted the attention of noted investor Warren Buffett, who owns about 6.5% of the company.
Growth Potential with Occidental Petroleum
Occidental Petroleum, led by CEO Vicki Hollub, is another company that Warren Buffett admires, largely due to its prioritization of profits over production. Occidental’s ROE and ROIC metrics, when compared to Chevron’s, provide insight into their operational strategies. Chevron benefits from diversified capital allocation across midstream and downstream segments, such as pipelines, refining, and distribution, which help stabilize its returns amid market shifts. In contrast, Occidental’s focus on upstream operations makes it more vulnerable to oil price fluctuations.
For investors uncertain about the future of oil markets, Chevron presents a stable option. However, for those anticipating rising oil prices, Occidental offers promising potential. The company recently acquired CrownRock, a shale producer in the Permian Basin, which is expected to yield approximately $260 million in additional cash flow for every $1 increase in oil prices. Should oil prices return to their 2022 highs, Occidental could generate over $10 billion in additional cash flow, representing 20% of its current market cap.
The success of Occidental’s acquisition of CrownRock and its broader capital allocation strategy, including dividends, share buybacks, and debt repayments, ultimately depends on future oil price trends. For bullish investors, Occidental’s direct exposure to rising oil prices makes it an attractive investment option.
