The past several years have been rollercoasters for oil and gas companies. At the onset of the pandemic, oil demand experienced a drastic decline, leading to a sharp decrease in prices. Then, the landscape shifted dramatically when Russia launched its invasion of Ukraine, causing oil prices to surge.

Many companies in the sector capitalized on their windfall profits, which they used to strengthen their financial positions and return capital to shareholders. Lately, however, oil and gas stocks have been the laggards in the S&P 500 index.

Since the start of 2023, Chevron (CVX -1.18%) stock has fallen nearly 11%, while the S&P 500 has surged 60% higher. If you're thinking of adding Chevron to your portfolio, consider the following first.

Chevron's cyclical business is dependent on oil and gas prices

Chevron is a key player in the oil and gas sector, and its performance can fluctuate based on commodity prices. This cyclical nature makes the stock sensitive to overall market conditions and how that impacts oil and gas prices.

During the mid-2010s, oil companies aggressively increased their drilling activities. This strategy led to high capital expenditures, and all the production sent oil prices downward. Companies in the sector faced falling earnings, triggering a decline in stock prices. The pandemic in 2020 then presented another demand shock for industry players.

Conversely, the surge in oil prices after Russia's invasion of Ukraine in 2022 resulted in crude oil prices reaching multiyear highs, leading to significant windfall profits for major oil and gas companies like Chevron.

With its integrated business model, Chevron aims to smooth out some of these fluctuations. It not only drills and produces oil and gas (upstream), but also has operations in the midstream and downstream sectors. This provides Chevron income from transporting its fuel, operating gas stations, and refining crude oil into petroleum products. The integrated approach helps mitigate some of the impacts of oil price volatility.

Chevron used its windfall profits from a couple of years ago to bolster its balance sheet and return more capital to its shareholders. Last year, the company returned $27 billion in capital to shareholders, including $11.8 billion in dividends and $15.2 billion in share repurchases. The company has grown its dividend over 37 consecutive years, illustrating its prudent financial management in a cyclical business and its commitment to returning capital to shareholders.

CVX Dividend data by YCharts.

Oil and gas producers are taking a prudent approach to capital expenditures

Although President Trump has encouraged more drilling, oil companies are taking a cautious and strategic approach to production. The Wall Street Journal reported in early February that "another American oil boom isn't in the cards soon, no matter how many regulations are rolled back, according to oil executives."

These companies hadn't forgotten what happened in the prior decade, when many companies ramped up capital expenditures (capex) and production, only to see oil prices plummet. Coupled with many countries' desires to reduce carbon emissions, oil and gas producers are taking a measured approach to their capex spending.

Chevron will continue to boost production, although it warned that upcoming Permian growth may be less than seen in prior quarters. The company plans to moderate growth and capital expenditures and focus on predictable free cash flow.

Image source: Getty Images.

The company is also awaiting a decision on whether it can acquire Hess. The $53 billion deal, including debt, was announced in October 2023 and would increase Chevron's portfolio in key oil-producing regions. It would give Chevron a 30% stake in Guyana's Stabroek Block, one of the largest oil discoveries in the last decade, as well as shale properties in the Bakken Formation in North Dakota.

A significant hurdle is an ongoing arbitration dispute with ExxonMobil, which claims it has a right of first refusal over Hess' stake in the Guyana project under their joint operating agreement. This dispute has delayed the deal and could jeopardize it if Exxon prevails. A final decision on this arbitration is expected around August of this year.

Buy, sell, or hold Chevron?

Chevron is one of the largest oil producers and publicly traded stocks on the market in the industry today. It has a stellar dividend payout history, but investors must keep in mind the cyclical nature of the business. If this isn't appealing, you probably want to sell or avoid owning the stock.

That said, Chevron has shored up its balance sheet and is well-positioned to continue growing its free cash flow. While Chevron stock isn't going to deliver explosive gains, it provides diversification and a reliable dividend, making it a solid stock to include in your diversified portfolio.

The company's deal with Hess is up in the air, so investors may want to wait for the outcome before deciding to buy. If approved, it could provide a big boost to Chevron's growing free cash flow over the next several years.