Soaring fuel prices have boosted inflation to a year-over-year increase of 8.6%, the highest level since 1981! And there is more to come: the lack of refining capacity is expected to drive up U.S. gasoline prices by more than a dollar, to $6 a gallon by August as oil and oil related products continue to go up in price.

U.S. oil producers, profiting from sky-high prices, are doling out billions of dollars to their lucky shareholders and building up their cash reserves. While that strategy is not popular on Main Street, it is winning many fans on Wall Street.

Reuters reports that earnings from U.S. shale fields, which accounts for two-thirds of U.S. oil output, could hit $90 billion this year, up from just $37 billion in 2021. This estimate, covering 32 publicly traded oil and gas producers, comes from the oil and gas consultancy BTU Analytics.

And, according to S&P Global Commodity Insight, the amount of cash generated by shale operators this year is set to be greater than the total earned over the past two decades!

From Investors’ Outhouse to the Penthouse

And after years of huge capital expenditures spent on finding more oil and gas, oil company executives decided to follow Wall Street’s advice and employ financial discipline.

The industry definitely needed more discipline. Between 2006 and 2019, the top 50 U.S. oil producers spent $170 billion more in capital expenditures than they earned from operations. These companies mainly used debt and some equity to cover the deficit.

That was not good. Or, as independent oil analyst Paul Sankey told Reuters: “Effectively, there were no returns” for shareholders.

That’s why investors, for over a decade, shunned energy companies. Oil companies’ weighting in the S&P 500 fell to less than 3% in 2020, from more than 16% in 2008. But today, energy stocks today are 5.1% of the S&P 500 and rising quickly.

The change in investor sentiment came as a result of oil producers shifting to a strategy of investing just a third of their cashflow into drilling and other capital expenses. That compares with spending most, if not all, of their cashflow just two years ago, according to data from the energy analytics firm, Enverus.

The CEO of Pioneer Natural Resources (PXD), Scott Sheffield, described this new strategy for the industry last year. In speaking of his company’s plan going forward, he said PXD would be: “growing [output] by no more than 5% annually and distributing a hefty chunk of free cash flow back to investors.”

In essence, shale producers like Pioneer are content raking in the money from high oil prices rather than producing more oil.

This is one of the central planks for the bull market in U.S. oil producers’ stocks. And it’s working: PXD stock is up over 63% over the past year. More broadly, the S&P 500 oil and gas sector is up more than 60% year-to-date. The S&P 500 itself is down about 22% year-to-date.

What Comes Next?

The U.S. government wants producers to step up their production of oil and gas in a major way soon.

But reality says that will not happen. Soaring input costs and supply chain constraints prevent oil companies from ramping up output quickly, even if they wanted to. Here are just a few examples of what will hold back increasing oil production:

• The price of frac sand has skyrocketed as mines shuttered during the pandemic take time to crank back into gear
• The cost of drilling rigs too has shot upwards, due to the general shortage in the market
• Labor costs have also risen as many skilled workers left the industry and are now demanding a lot more money to return

Despite these rising costs, I expect a continuing bonanza for the oil exploration and production firms.

The ongoing unusual situation – limited capital expenditures and soaring cash income from high oil prices – means that some of the largest shale companies could theoretically buy themselves back entirely in less than seven years!

That makes the entire shale industry a buy. So, for a broad way to play this, an exchange traded fund is the perfect solution.

The Invesco Dynamic Energy Exploration & Production ETF (PXE) is the ETF that I own. It is up 77.5% over the past year and 63% year-to-date.

You can make the purchase anywhere in the low $30s, with similar gains going forward for at least the next year.