Energy Related Income Is the Sweet Spot for Yield 

Bryan Perry

A former Wall Street financial advisor with three decades' experience, Bryan Perry focuses his efforts on high-yield income investing and quick-hitting options plays.

Depending on how one views the snapback rally late last week, it would seem a window of opportunity briefly opened for investors looking to hedge against inflation, rising rates and geopolitical volatility. After the price of wheat spiked above $9/bushel and WTI crude spiked to over $100/bbl on the initial headlines of the Russian invasion into Ukraine, the market took on the narrative that a brokered meeting this week between a Russian delegation and Ukraine leaders signaled that that the worst was over. 

On this sentiment shift, WTI retreated to close out Friday’s session at $91.59/bbl with most of the leading oil stocks consolidating recent gains. The situation in Ukraine can break in either direction suddenly since China’s leader Xi Jinping had a call with Vladimir Putin inducing Putin to take on the appearance of being more accommodative towards negotiations, triggering the big gain for stocks into the weekend. 

China is in a diplomatic box. On the one hand, Xi is clearly backing Putin, calling the invasion a “Russian operation” and inviting global criticism for shielding Moscow. China sees the Ukrainian situation as diverting attention and assets away from U.S. efforts to tamp down Chinese aggression in the Indo-Pacific region. On the other hand, China taking sides with Russia draws fire from every corner of the world that only further elevates the level of mistrust and damage to China’s profile. 

NATO and the U.S. are leading a wave of heavy sanctions on Russia that will force it to depend much more heavily on China buying its oil, wheat and other exports — which will be seen as further tangible evidence of its support for Russia. Such actions would severely tarnish China’s ongoing claim that it is a major advocate of the sanctity of nation-state sovereignty, which is one of the great hypocrisies of modern times. Russia is the largest producer of oil in the world and exports 29% of the world’s wheat supply. As of Sunday, NATO had not placed sanctions on Russian oil exports. 

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Source: https://worldpopulationreview.com/country-rankings/oil-producing-countries

China is the top importer of oil in the world, soaking up 25.8% of total global oil imports, valued in excess of $176 billion. Any major interruption of Russian oil exports will very likely have a material impact on spot prices that could have oil trading back up through $100/bbl. like a hot knife through butter. It’s almost hard not to see this scenario unfolding in the midst of what looks to be a Kremlin that is very determined to succeed in its aim to take Ukraine.

Against this very challenging backdrop of phenomenal fluidity, the energy sector has proven to be a bastion of strength in portfolios for 2022. It’s hard to see how this plays out to where oil prices decline meaningfully, thereby further supporting the bullish investment thesis driving the energy sector higher. Shares of the S&P Energy Sector SPDR ETF (XLE) hit a high of $70.50 on Feb. 11 and have spent the pat two weeks digesting gains. 

What’s important to note is that when XLE hit an all-time high back in June 2014, it was due to concerns about possible international supply disruptions along with other factors that included improving economic conditions and sanctions on Iranian exports. And today, we have curbs on U.S. oil production, which is only making matters more sensitive to sudden spikes in crude prices. 

Shares of XLE pay a current dividend yield of 3.42%, whereas Chevron Corp. (CVX) pays 4.05% and Exxon Mobil Corp. (XOM) pays 4.52%.

Because of the newfound tidal wave of profits from higher oil prices, a handful of companies have adopted the model of what are called fixed-plus variable dividend policies, a departure from traditional dividend payouts. Instead, companies aim to attract investors by offering a substantial base dividend that is positioned to grow over time along with a variable and/or special dividend that returns more of the profits back to shareholders. This is also in addition to increasing stock buybacks. 

Case in point, Devon Energy Corp. (DVN) approved a fixed-plus-variable dividend of $1.00 per share based on fourth-quarter performance. At that same time, the company authorized an increase of 60% in its share-repurchase plan to $1.6 billion. Devon stated that after its fixed dividend is funded, it intends to pay out up to 50% of future free cash flow in the form of variable dividends. Taking the current quarterly $1.00 per share dividend as a forward guide to its 2022 annual payout, shares of DVN are yielding 7.2%. 

Pioneer Natural Resources Co. (PXD) and Coterra Energy Inc. (CTRA), the combined merger of Cabot Oil & Gas and Cimarex Energy, are also featuring variable dividend policies. This approach is smart in that smaller base dividends are more manageable in downturns while during periods where profits are gushing, oil companies can temporarily increase payouts. 

The allure of high, fixed dividends being paid by struggling companies almost always results in the underlying stock losing value on the notion of an eventual slashing of the dividend, or having to take on debt to support it. The market tends to punish the stocks of companies that reduce or omit dividends entirely. More is being written by energy analysts about how this model is the way of the future for the energy stocks. 

So, while the factors that hold oil prices at their current levels with risk to further upside pricing looks to persist for the foreseeable time, one of the most compelling high-yield hedges against inflation, global supply disruption, Russia, Iran, China and the deep denial of the Biden administration’s energy policy are blue-chip energy stocks and exchange-traded funds (ETFs). There’s always a bull market somewhere, and the oil sector is in a raging one.   

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