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Summary

  • The restriction imposed on the drilling activity of the company can put pressure on the stock valuation in the short term but it will not hurt the long-term prospects.
  • The spinoff of the California business will make a more liquid based production and reserves base for the company.
  • With the lower drilling costs, the Permian Basin continues to be the major source of the company’s production and growth.
  • The company is determined to increase shareholders’ returns as the proceeds from the sale of Hugoton assets are to be used for share buybacks.

The shares of Occidental Petroleum (NYSE:OXY) witnessed a decline of $5 in just two days due to the news that the city council of Carson, California, voted to impose a 45 day restriction on oil and natural gas activity. The council decided to halt negotiations on development of about 200 wells until Occidental completes the spinoff. The city council expressed its concerns about controversial fracking techniques, negating the claims of the company that no such techniques will be used in wells.

Carson is the third local government in California since September to impose restrictions on drilling. Oil industry professionals believe that the debates in cities like Carson reflect an irrational fear of modern techniques of oil drilling. Occidental promised to disguise and soundproof the operations in a warehouse complex. It also ensures to pay for a monitor to make sure that the operations are in compliance with city regulations.

Although the restriction led to a decline of nearly 5% in two days I believe that it is not something that continues to make the company weak in the long term. However, that is a concern that needs to be addressed and in my opinion Occidental will be able to manage it. Moreover, the long-term prospects of the company are still intact.

The spinoff will be completed by the end of 2015. Upon successful completion of the spinoff, the new company will become California's largest oil and natural gas producer. It will be the largest oil and gas mineral acreage holder with approximately 2.3 million net acres. During 2013, it reported having total reserves of 744 mmboe with reserve replacement of around 154%. The breakup of the company's total reserves can be seen in the figure below.

(click to enlarge)

Source: California fact sheet

The step is purely a geographical split. All operations that take place in California will be spun off while the remaining divisions will remain a part of the existing company. The company believes that the California part of the business would do better as a stand-alone business.

In addition to the spin off, Occidental also announced the sale of its assets in the Hugoton field for $1.4 billion. The average net production from the Hugoton field in 2013 was approximately 110 million cubic feet equivalent per day, 30 percent of which is oil. Given that the net production from the field was only comprised of 30% oil, the sale of the field will result in more oil-based production and reserves for the company.

The transaction is expected to be completed by April 30th 2014. Occidental has announced it would utilize these proceeds to increase its share repurchase authorization by 30 million shares.

Permian Basin

The Permian Basin accounts for approximately 15 percent of total US oil production. Occidental Petroleum holds a strong position in the Permian Basin and contributes almost 16 percent of total oil produced by the company.

The company estimates more than 2.5 billion boe in reserves and potential resources that make up to 15 plus years of development and growth opportunities. Moreover, the company is also progressing towards developing 1.4 billion net barrels of oil equivalent and reserves and potential reserves.

In addition, the company has significantly improved its returns. A typical well in the Permian is reported to be earning an internal rate of return of 48% reflecting an increase of almost 100 percent from a year ago.

Concluding Remarks

Occidental Petroleum is boosting to its oil operations. The decision to spin-off its California business is a part of the company's strategy to grow as a smaller and more oil-focused company. It will also allow the company to focus more on its most profitable asset, Permian Basin. During 2013, the company increased its oil production in the US by 4.3%, and going forward it plans to double the US production growth to 9% in the current year.

With the recent correction in the stock price, the stock is now trading at an attractive dividend yield of 3.10 percent. In addition, the company will be generating sale proceeds of $1.4 billion that will be utilized for its new share buyback authorization. Therefore, I recommend buying the stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Is It The Right Time To Buy Occidental Petroleum?