The Energy Sector Is on Fire. Is Occidental Petroleum the Best Way to Play It?

The energy sector has been red-hot this year. WTI, the primary U.S. oil price benchmark, is up more than 20% this year to around $70 a barrel. While that's well off its peak in the triple digits, oil is still much higher than it started the year and could remain elevated well into 2027 as the market recovers from the prolonged closure of the Strait of Hormuz.

The surge in crude prices has benefited Occidental Petroleum (NYSE: OXY), which has also rallied more than 20% year to date, crushing the S&P 500's nearly 8% return. Here's a look at whether it's the best way to play the energy sector this year.

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Starting from a position of strength

Occidental Petroleum has spent the past several years enhancing its scale and balance sheet. The oil company paid $38 billion (plus the assumption of debt) to acquire Anadarko Petroleum in 2019 and another $12 billion to buy CrownRock in 2023. It heavily relied on debt financing to close both deals, burdening its balance sheet. As a result, Occidental has spent much of the last five years focused on debt reduction, including the sale of non-core assets.

The company achieved its initial targeted debt level of $15 billion earlier this year by selling its OxyChem subsidiary to Berkshire Hathaway for $9.7 billion. That sale meaningfully reduced its interest expenses and capital spending. That drove Occidental's expectation that it would deliver a more than $1.2 billion improvement in its free cash flow this year at the same oil price as last year (mid-$60s). This incremental free cash flow would enable it to continue increasing its dividend (8% raise in February) and further strengthen its balance sheet toward its new target of reaching $10 billion in debt. It also had the flexibility to opportunistically repurchase shares.

Strong upside to higher oil prices

Occidental Petroleum's heavy investments to scale its oil and gas business put it in a stronger position to capitalize on higher crude prices this year. For example, every $1 increase in the average annual oil price will add about $265 million to its free cash flow.

While oil prices are currently in the $70s, most Wall Street banks expect crude to average around $85 to $90 a barrel this year. Even though Iran has agreed to reopen the Strait of Hormuz and allow oil to flow freely, restoring supply from the Persian Gulf could take time. Further, the global economy needs to rebuild its oil inventory levels, which it has drawn down during the closure. That recovery could last until 2027, keeping crude prices in the low to mid $70s next year.

This outlook suggests Occidental Petroleum should generate more excess free cash flow over the coming year. That will enable it to achieve its new balance sheet target faster and start returning more money to shareholders through repurchases, further boosting shareholder value.

A great option

Occidental Petroleum initially expected to generate more than $1.2 billion in additional free cash flow in 2026 at the same oil pricing level as last year. The company will likely exceed that target due to the uptick in crude prices, which could remain elevated into next year. While Occidental isn't the only oil company in a strong position to capitalize on this year's pricing, it's a great option for investors seeking an energy stock to cash in on the red-hot oil market.

Matt DiLallo has positions in Berkshire Hathaway. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool recommends Occidental Petroleum. The Motley Fool has a disclosure policy.