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The stock market has entered into bear market territory this year due to the surge of inflation to a 40-year high and fears that the resultant interest rate hikes of the Fed may cause a recession. On the contrary, oil and gas stocks are thriving in the current environment thanks to the rally of the prices of oil and gas to 13-year highs. These prices have skyrocketed primarily thanks to the sanctions of western countries on Russia for its invasion in Ukraine. As these sanctions are not likely to be withdrawn in the near future, oil stocks are likely to continue to outperform the broad market by a wide margin. In this article, we will discuss the prospects of three oil and gas stocks with high dividend yields, namely BP (BP), ConocoPhillips (COP) and Kinder Morgan (KMI).
 

BP

Most investors have forgotten the catastrophic accident of BP in the Gulf of Mexico in 2010, but the oil major is still paying appreciable amounts for that accident. BP has paid approximately $70 billion for the accident so far. This amount is almost equal to all its earnings since 2010. Even in 2019, nine years after the accident, BP paid $2.4 billion (24% of its earnings) for compensations. The company expects to pay $1.4 billion for the accident this year.

Moreover, BP was caught in the coronavirus crisis with an excessive debt load. Consequently, it cut its dividend by 50% in 2020 while it also announced a major shift in its strategy in that year. According to its new strategy, BP will increase its investment in renewable energy sources 10-fold and it will greatly reduce its investment in oil and gas projects. As a result, the oil major expects to reduce its oil and gas production by -42%, from 2.6 million barrels per day now to 1.5 million barrels per day in 2030. Due to the uncertainty caused by the major strategic shift of BP and the collapse of oil and gas prices caused by the pandemic in 2020, the stock of BP collapsed to a 25-year low in that year.

However, BP has recovered strongly from the pandemic. Thanks to the recovery of global oil consumption from the pandemic and the sanctions of western countries on Russia, the markets of oil and gas have tightened to the extreme this year. Russia produces 10% of global oil output and approximately one-third of the natural gas consumed in Europe. As a result, the prices of oil and gas have rallied to 13-year highs this year. This is an ideal business environment for all the oil majors, including BP.

In the first quarter, BP grew its earnings per share 56% sequentially, from $1.23 to a decade-high of $1.92, and thus exceeded the analysts’ estimates by an eye-opening $0.53. BP has exceeded the analysts’ consensus for five consecutive quarters. This is a testament to its impressive business momentum.

Moreover, BP it taking full advantage of the exceptionally favorable commodity prices and is reducing its debt at a fast pace. The company has reduced its debt for eight consecutive quarters and has stated that it expects to continue raising its dividend by 4% per year if the price of oil remains around $60 or higher. In such a scenario, BP also expects to repurchase $4 billion of shares per year (~4%). Overall, BP is offering an above-average dividend yield of 4.2% and is likely to offer meaningful dividend raises as well as share repurchases as long as the price of oil remains above $60.
 

ConocoPhillips

ConocoPhillips is the largest independent oil and gas producer in the world, with a production of 1.7 million barrels per day. It has a striking difference from the other well-known oil majors, such as Exxon Mobil (XOM), Chevron (CVX) and BP, i.e., it is a pure upstream company and hence it is much more sensitive to the gyrations of the price of oil.

ConocoPhillips executed a major acquisition at the most opportune time. It acquired Concho Resources for $9.7 billion in an all-stock deal in 2020 and thus greatly enhanced its shale oil production. As it executed its acquisition at the depth of the coronavirus crisis and the price of oil has rallied impressively since then, the deal has offered an excessive rate of return to ConocoPhillips.

As ConocoPhillips is a pure upstream company that does not hedge its output, it has benefited more than the other oil majors from the rally of the oil price to a 13-year high. In the first quarter, its average realized oil price jumped 70% over last year’s quarter and thus the company more than quadrupled its earnings per share, from $0.69 to an all-time high of $3.27. Given the sustained rally of the price of oil and the absence of any sign of withdrawal of sanctions, ConocoPhillips is on track to post record earnings per share this year.

As the stock of ConocoPhillips has nearly doubled over the last 12 months, to a new all-time high, it is offering a regular dividend yield of only 1.7%. However, the oil major has an exceptionally low payout ratio of 14% and has also announced a special quarterly dividend of $0.70 for the third quarter. The special dividend offers an additional dividend yield of 0.6%. Even better, more special dividends are expected in the upcoming quarters thanks to the favorable environment of commodity prices.
 

Kinder Morgan

Kinder Morgan is one of the largest energy companies in the U.S. It is engaged in storage and transportation of gas and oil products and owns an interest in or operates approximately 83,000 miles of pipelines and 144 terminals.

Kinder Morgan has one of the most resilient business models in the energy sector, generating nearly all its cash flows from fee-based contracts and minimum-volume contracts. The company generates 68% of its operating income from minimum-volume contracts and thus its customers pay a minimum amount every year even if they transport lower volumes than expected. Another 24% of operating income comes from fees, which are hardly affected by the swings of commodity prices. As a result, the vast majority of the cash flows of Kinder Morgan are reliable even under adverse business conditions.

This has certainly proved to be the case throughout the coronavirus crisis. While most energy companies saw their earnings collapse in 2020 due to the pandemic, Kinder Morgan incurred just an 8% decrease in its distributable cash flow per share in that year. Even better, it has fully recovered from the pandemic and is thriving at the current environment.

Kinder Morgan is currently offering a 6.1% dividend yield. Given its rock-solid payout ratio of 52% and its resilient business model, the company is likely to continue raising its dividend for years. The combination of the yield and the safety of the dividend of Kinder Morgan are especially attractive in the current investing environment, in which investors are struggling to protect their portfolios from eroding amid high inflation.
 

Final Thoughts

After oil and gas stocks were declared “dead stocks” in 2020 due to the pandemic, they have outperformed the S&P 500 by an impressive margin in 2021 and 2022. The above three energy stocks are offering high dividend yields with a wide margin of safety. Therefore, they are attractive candidates for the investors who want to protect their portfolios from soaring inflation.