Occidental Petroleum: Navigating Challenges And Driving Growth

Dimitrios Kambouris

Investment Thesis

Despite a Q2 2023 earnings slump attributed to market headwinds, Occidental Petroleum Corporation (NYSE:OXY) has positioned itself for a long-term solid performance by leveraging its diverse portfolio of assets and operational efficiency. The article explores the company's strategic fundamentals (trifecta strategy), encompassing diverse assets, steady production climb, operational excellence, and commitment to shareholder returns, reaffirming the buy rating for the stock, which still offers an attractive entry point.

Occidental Faces Challenging Q2 2023: Earnings Drop, Production Rises, & Strategic Moves Unveiled

Occidental reported a challenging Q2 2023 performance with a substantial YoY decrease in adjusted earnings, primarily attributed to diminished realized prices for both oil and gas as well as reduced crude oil volumes. Q2 net income plummeted to $605 million, or $0.63 per share, a sharp decline from the $2.55 billion, or $2.52 per share, recorded in Q2 2022. The downturn in earnings was accompanied by a 37% YoY decrease in revenues, amounting to $6.73 billion, falling short of the analyst consensus of $6.93 billion.

Notably, critical drivers of the decline were the 36% drop in Q2 2023 oil and gas sales, primarily stemming from a 32% decrease in the average realized price of oil to $73.59 per barrel and a significant 78% plunge in the average realized gas price to $1.36 per Mcf.

Despite the challenging market conditions, Q2 total production rose 6% year-on-year to reach 1.22 million barrels of oil equivalent per day (BOE/day), surpassing midpoint guidance. This positive production trend led the company to cautiously raise its full-year production guidance to a range of 1.19 million to 1.24 million BOE/day, up from the previous outlook of 1.175 million to 1.215 million BOE/day.

Earnings Presentation (Occidental Petroleum)

Additionally, Occidental announced its decision to discontinue exploration efforts in Wyoming's Powder River Basin and took a related after-tax impairment charge of $164 million. Notably, the company executed a buyback of $522 million worth of Berkshire Hathaway's (BRK.A) (BRK.B) preferred stock during the quarter, representing a 12% redemption of Berkshire's initial $10 billion investment used to fund Occidental's acquisition of Anadarko Petroleum in 2019.

Financially, Occidental demonstrates stability and effective capital management. Despite planned maintenance, the company generated over $1 billion in free cash flow during Q2. Its prudent approach to taxes and working capital management enhances liquidity. The guidance for the remainder of the year underscores Occidental's anticipated strong performance, focusing on operational efficiency, growth, and maintaining a robust balance sheet.

OXYChem Division Holds Strong, Midstream And Marketing Challenges Ahead

Despite observing weakened pricing in PVC and caustic soda during Q2, Occidental maintains its full-year guidance of a pretax income midpoint of $1.5 billion, positioning itself for another robust year in its OXYChem division. An anticipated return to normalized seasonality indicates that Q4 will likely represent the lowest earnings of the year.

However, a more intricate analysis involves Occidental's Midstream and Marketing segments. Due to projected market changes in the latter half of the year, the margins associated with shipping crude from Midland to the U.S. Gulf Coast are expected to shrink further following the annual FERC tariff revision.

This tariff adjustment has added approximately $2.55 per barrel to pipe costs. Simultaneously, the pricing for long-haul capacity is expected to decrease, and fewer opportunities in the gas market are foreseen due to narrowing spreads across basins. Furthermore, sulfur pricing is expected to soften in H2 2023. These factors collectively shape the trajectory of Occidental's energy trading and marketing activities.

On the downside, Occidental faces significant risks, as EPS is expected to decline by an average of 20.00% annually over the next 3-5 years. The company's financial position is characterized by a high level of debt, which could impact its flexibility and ability to manage downturns effectively. Lastly, operating margins have decreased from 44.27% to 20.04% over the past year, raising concerns about the company's operational efficiency.

Strategic Focus: Sustainability, Shareholder Returns & Capital Allocation

For sustainability, Occidental intends to strike a balance between growth and shareholder returns. The company aims to maintain a moderate level of capital spending, similar to the activity level observed in the latter half of the current year, and projects this into the following year. Occidental demonstrates a commitment to repurchasing common shares and indicates the potential for repurchases and preferred share redemptions, driven by expectations of a favorable pricing environment in the oil and gas market.

Occidental's strategic focus on sustainability and shareholder returns is evident. Its midstream business ensures flow assurance, even during macroeconomic adversities. In contrast, its low-carbon venture business positions the company to decarbonize at scale, adding critical value to shareholders and creating a moat for a long-term competitive edge. It can be inferred from Warren Buffett's take on Occidental's stock as, due to its substantial value and moat, Buffett has been buying Occidental's shares within a specific price range below $60 since 2022.

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Further, OxyChem's resilience in price cycles contributes to consistent free cash flow, balancing the oil and gas business. Substantial share repurchases and redemptions of preferred equity highlight Occidental's commitment to shareholders.

Specifically, share repurchases have significantly reduced preferred equity, positively impacting annual preferred dividends. However, certain conditions are in play. Cumulative distribution of $4.08 per common share over the past 12 months may dip below $4 during Q3 2023 due to the concentration of share repurchases and current commodity price trends. This trend underscores the potential influence of commodity prices on Occidental's strategic decisions, including preferred equity redemption.

Additionally, share repurchases are emphasized to create value per share for investors. Repurchases are seen as crucial, particularly given the company's perceived undervaluation. The trigger point for share repurchases is around $70 per barrel, with the flexibility to engage in both share repurchases and preferred share actions at higher oil prices.

Regarding CapEx, the consensus estimate suggests a potential 4% increase in spending to maintain flat production levels in 2024. The company acknowledged that service costs might not see a significant reduction but refrained from confirming any anticipated increase in spending for the following year.

Moreover, capital spending for the quarter totaled around $1.6 billion, and there's an expectation of a modest decrease in Q3 2023, followed by a more pronounced reduction in Q4. The decrease is attributed to scaled-back working interest and growth activity in the Permian region, aligning with Occidental's strategic plan.

Finally, a settlement linked to environmental remediation in the second quarter is projected to yield $350 million in Q4, contributing to lower reported overhead. Despite this settlement, full-year guidance for overhead expenses remains unaltered on an adjusted basis.

Value-Driven Asset Mix: Occidental's Shale And Conventional Reservoir Strategy

Occidental's asset portfolio is its foundation for value creation. A unique blend of assets balances short-cycle, high-return shale assets in the Permian and Rockies with lower-declination, solid-return conventional reservoirs in the Permian, Gulf of Mexico (GoM), and international locations. The diverse mix allows Occidental to weather low price cycles with its conventional assets and capitalize on growth opportunities during moderate to high price cycles through its shale assets.

Shale assets contribute 60% of oil and gas production, while the international segment is limited to Oman, Abu Dhabi, and Algeria. This year's production mix targets approximately 53% oil, 22% NGLs, and 25% gas, with 70% of the gas within the United States.

In the Permian, higher operability and better-than-expected healthy performance are enhancing productivity. Additionally, Occidental's international teams have delivered strong results, as exemplified by the early commissioning of the Al Hosn expansion in Oman.

The successful Al Hosn gas expansion project is characterized as a low-capital project with promising cash flow potential. Occidental's Middle East operations, particularly in Oman, are expected to contribute to healthy production. The company's emphasis on innovation, subsurface modeling, and technologies like Occidental's for production optimization demonstrates a commitment to maximizing output.

Earnings Presentation (Occidental Petroleum)

Also, there's a focus on the legacy Anadarko assets in Texas and Delaware, deemed top-tier and highly valuable. These assets are expected to rebound in Q4, contributing to earnings and cash flow. Southeast New Mexico and Texas-Delaware regions are integral to Occidental's program moving forward.

Finally, the Rockies trajectory demonstrates strength in the year's first half, followed by growth. This improved performance is attributed to innovation in surface infrastructure, like tankless designs, and optimizing artificial lift methods. As a result, this showcases Occidental's commitment to efficiently extracting resources and maintaining high-quality base production.

Path To Operational Excellence & Growth

Operational efficiency is another driver of Occidental's growth. Exceptional Q2 operational performance surpassed guidance by 42,000 BOE daily, enabling an upward revision of full-year production guidance. Notable accomplishments include improved base production and faster drilling times, setting new records in lateral drilling. Occidental's operational improvements extend to productivity, with consistent upgrades of secondary benches to top-tier performers driving impressive organic reserve replacement ratios.

In the Gulf of Mexico, a shift is observed from considering it primarily a cash generator to a potential growth area. Advanced data analytics, including artificial intelligence, are expected to drive this change, optimizing production and adding value over the next few years.

Regarding production, Occidental's Rocky Mountain operations in previous years saw underinvestment and decline. The company has restored capital allocation to the region, resulting in a shallower decline and even modest growth. The focus on operational improvements and efficient allocation of resources is driving a more positive production trajectory.

Fundamentally, the company emphasizes improving productivity and reducing non-productive time, which has led to increased efficiency in operations. Certain costs are plateauing, including labor costs, although challenges persist in acquiring specialized skills for field operations, such as truck drivers and welders.

Finally, the DJ Basin's completion design and well spacing strategy in the Delaware Basin is focused on maximizing estimated ultimate recovery (EUR) while reducing costs. The transition from 18-well to 12-well spacing, combined with increased fracturing intensity, is a cost-effective way to maintain or enhance EUR. However, Occidental maintains flexibility in well spacing decisions based on unique geological and reservoir characteristics.

Earnings Presentation (Occidental Petroleum)

Occidental's Ambitious Low-Carbon Ventures

Within its Low Carbon Ventures (LCV) initiatives, Occidental announced collaborations for carbon dioxide removal and capture. These efforts reflect Occidental's drive towards net-zero goals and underscore its commitment to sustainability. While the specific details of these ventures are not provided in the text, they indicate a significant focus on environmental considerations and innovation.

Furthermore, the company's collaboration with ADNOC (Abu Dhabi National Oil Company) on carbon capture and sequestration initiatives Occidental Petroleum emphasizes its expertise in subsurface operations, particularly CO2-enhanced oil recovery (EOR), and highlights its track record of partnering with ADNOC on challenging projects. The executives anticipate potential opportunities for direct air capture and sequestration, focusing on aligning with both companies' net-zero emission goals.

Occidental All In on Carbon Capture (Occidental Petroleum)

Additionally, Occidental's collaboration with strategic partners, such as ADNOC, is underlined as a way to leverage expertise and resources to accelerate project development. Occidental's confidence in ADNOC's readiness to move forward, recognizing Occidental's successful track record in project execution. The approach aligns with Occidental's goal of creating synergies and accessing complementary capabilities to drive technological innovation and cost efficiencies.

Moreover, Occidental's leadership, represented by CEO Vicki Hollub and President of Operations Richard Jackson, signifies a strategic shift toward lower-carbon ventures. Notably, it highlights progress with the Stratos DAC plant in Texas, showcasing carbon dioxide removal (CDR) technology advancements. Occidental aims to leverage its track record in major project management to attract partners like ADNOC for equity investments.

While it acknowledges the importance of showcasing progress in Stratos, Occidental also emphasizes the significance of long-term cost reduction and massive potential in direct air capture (DAC) technology, aligning with sustainability goals. Updates on the Stratos DAC plant's construction progress indicate that the project is about 23% complete.

Occidental's carbon capture and sequestration efforts focus on leveraging existing infrastructure and partnerships to optimize costs and returns. The company aims to deploy capital where it can deliver the greatest value and is actively engaged in developing sequestration hubs in the Permian and Gulf Coast regions.

Occidental is optimistic about the demand for its CDR products, particularly in sustainable aviation fuels (SAF), where it sees a firm fit. The company believes CDRs can command competitive market pricing, using price ranges for sustainable aviation fuels as a reference point ($800 to $1,000 per ton). Finally, regulatory initiatives, such as the European Parliament's requirement for a 2% SAF mix, could drive demand and prices for CDRs.

Takeaway

In conclusion, Occidental benefits in the long term through its strategic trifecta approach of capitalizing on diverse assets, operational excellence, and commitment to shareholder returns. Despite Q2 2023 earnings challenges, Occidental's focus on efficient production, steady growth, and innovative partnerships positions it for solid performance.

Occidental uses shale and conventional assets to adapt to price cycles and growth phases. Though risks exist, Occidental's stability, robust balance sheet, and sustainability efforts indicate a resilient energy player navigating industry fluctuations for sustained value creation.