Occidental Petroleum (OXY) beat analyst estimates with its third quarter earnings of $1.70 per share, slightly above the Zacks Consensus Estimate of $1.63. Oxy's profits in the third quarter fell 22% on lower prices, even as it increased spending to boost production by 8% overall during the quarter. The company was hit not just by natural gas prices but also a dip in the average price per barrel of Brent oil and its own realizations on this commodity, which amounted to 88% of the average Brent price.
This is diametrically opposed to the performance of peer Encana (ECA), which posted an $1.24 billion net loss, driven by a $1.19 billion non-cash impairment on its natural gas properties. This brings Encana's losses for the year to $2.7 billion. Earlier this year Encana started building out its oil and natural gas liquids portfolio, which helped offset its losses through an 8% increase in liquids production compared to the third quarter 2011. This was possible in part because Encana is now edging in on Oxy's holdings in several star US plays. Yet Encana appears better positioned than Oxy for recovery in the long term.
Easy Production Ignored
Oxy expects that gas and to a lesser extent natural gas liquids production will decrease over the next few quarters. Its neglected gas-rich West Virginia acreage overlies the Marcellus and Utica shales. Interestingly, as Oxy ignores this territory, Chesapeake Energy (CHK) CEO Aubrey McClendon quietly mortgaged his personal holdings in West Virginia earlier this year through Jamestown Resources, an affiliate he owns from which a portion of drilling profits derived flow through to Chesapeake, just another of the complicated subsidiary deals in which the company is enmeshed.
The worst part for Oxy about this neglected acreage is that even though natural gas prices are low, at least these fields produce - and in record volumes. I think the problem is that Oxy did not realize the importance of bringing down its per unit costs until it was already hedged in by low prices, and is now incapable of bringing up natural gas at a profit from most of its domestic assets. This leaves it exploring non-producing assets in the hopes of striking it big, where there is no evidence that it will.
California Properties an Anchor
Oxy's California explorations overall are not delivering the returns Oxy anticipated, even as operating costs in this area are double what they were when Oxy announced its intentions to help California benefit from the unconventional shale boom enveloping the rest of the U.S. Oxy entered the California drilling market in a big way around the same time as Exxon Mobil (XOM) started its record setting unconventional offshore exploration efforts in the state, but in an ironic flip, where Exxon Mobil is successful with unconventional recovery, Oxy is failing with conventional recovery.
To those who follow California's economy on a macro scale, this can come as little surprise; I for one think it's a surprise that Oxy didn't see it coming. The tangled permitting process in California is just one hurdle, and one that is growing rather than shrinking; California's ever vocal activists are now attempting to enjoin authorities from permitting fracking within state boundaries. It doesn't help that much of the technology Oxy hopes to bring to bear on its California assets is relatively prospective, and therefore more costly and more difficult to permit. Options Oxy is keeping on the table for extraction include water and steam flooding. The state's budget problems are also well known, and are leading to a tax and regulatory environment generally unfriendly to businesses of Oxy's size and stature.
Oxy remains optimistic in the future potential of these assets, led by its recently started Elk Hills gas plant and what Chazen calls a "major steam flood project in Lost Hills." Shareholders are not backing that optimism, and grilled Oxy executives about the company's "failure to be more transparent" about California operations on the company's third quarter conference call. Chazen tried to defend the strategy by pointing towards decline rates in unconventional drilling compared to decline rates in conventional drilling, a practice in several of Oxy's California fields, but I don't think this holds up, especially in light of Chazen's admittance of high decline rates in Elk Hills, previously held up as one of Oxy's more promising assets.
It's certain, as Chazen pointed out, costs of $200,000 per well in Lost Hills look good on paper but Chazen followed up this comment by inexplicably noting "we've shown you what in aggregate is going on, which is all you should really care about." Oxy, take note: Any operations that appear to be a cash siphon without a clear track to returns or even a clear accounting is going to cause concern for shareholders.
Is There Potential for a Takeover?
Oxy is cautious about what the next few quarters will bring, and Oxy President and CEO Stephen Chazen gave major hints on the company's third quarter earnings conference call that major strategy changes could be on the horizon. One of the more interesting comments Chazen made, and there were many, was in response to a question about the possibility of splitting up or outright selling Oxy. His response was simply, "I don't know if anybody's got enough money to buy it." Does this mean that Oxy is, in whole or in part, for sale?
With a market cap of $64.1 billion, it would take a consortium of investors to take over the firm, but that isn't outside the realm of possibility. Indeed, given Chevron's (CVX) late entry into domestic shale, it could be one of the leading candidates for an offer on prime Oxy assets in the Permian and elsewhere. Royal Dutch Shell (RDS.A) is also a firm that could be interested in taking over Oxy, though I would expect it to do so as part of a consortium - probably involving its overseas partners who are showing ever increasing interest in U.S. unconventional resources. Indeed, Shell is active on the asset trading front this year, acquiring roughly $6 billion in assets while divesting roughly the same amount. This leaves its cash position intact and its ability to maneuver almost unrivaled in the industry.
Oxy is currently trading around $79 per share, with a price to book of 1.6 and a forward price to earnings of 9.6. Exxon Mobil is trading around $92 per share, with a price to book of 2.6 and a forward price to earnings of 10.5. Encana is trading around $23 per share, with a price to book of 3.0 and a forward price to earnings of 29.9. Chesapeake is trading around $20 per share, with a price to book of 0.9 and a forward price to earnings of 11.2. Shell is trading around $70 per share, with a price to book of 1.3 and a forward price to earnings of 10.8.
Given its current direction, rapid and large divestments or even a buyout are among the best mid-term scenarios Oxy could hope for. While many hoped that when Chazen took the reigns of the company Oxy would boost its growth, these hopes are being disappointed. It is steadily more apparent that Chazen is not finding his footing as the leader of Occidental Petroleum, and that's exactly what Oxy needs right now to make itself look attractive against stagnant growth.