Occidental Petroleum Grooves With Changing Oil Market Dynamics

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About: Occidental Petroleum Corporation (OXY)
by: Jennifer Warren

Summary

Oil prices are settling into their more traditional patterns of movements related to fundamentals and geopolitics, i.e., U.S. supply is factored into OPEC's decisions more rationally.

Occidental Petroleum is a resilient energy conglomerate with forward-looking leadership.

Steady dividends and conservative financial management are hallmarks of the firm.

Falling oil prices and projected softening of demand may take some of the juice out of recent oil and gas company performance. However, the potential hit may not be as bad, depending on a firm’s business model. Large-cap exploration and production Occidental Petroleum (OXY) is a diversified energy conglomerate that's more oil than gas-weighted. During the oil price rout, the firm weathered the storm, and its initially conservative approach to shale production and capital spending proved to be a smart strategy.

Oil prices were rising higher until the Kingdom said it would help keep the market supplied, the timing of which followed the political fallout from the deceased Saudi journalist. Trump also complained previously about rising oil prices. But demand and supply are finding their respective paths outside of politics, whether domestic or geopolitical. U.S. crude prices hit their high of $76 on October 3. December-dated light, sweet crude settled at $63.69. Spot prices for WTI and Brent for the week ended 10/29 were $67 and $77, respectively.

Some Fundamentals

• Demand for oil globally ~100 million b/d in 2018, estimated at 101.5 in 2019.

• OPEC will keep things tight.

• U.S. share of global liquids of 12% in 2017 is expected to grow but steadily, of which Texas produces ~4.5 M/b/d, and Permian production is more than 3.5 million.

• Prices were expected to be in the $80 range for Brent and slightly less for WTI, per the Dallas Fed in October. In its October forecast, the EIA estimated Brent averages $75 and WTI $70 in 2019, but the latest forecast of November 6 estimates Brent averaging $72 and WTI $65 (here).

Supply concerns

Concerns about Iran’s shortages were weighing heavily on the market’s psyche, contributing to some of the oil price run-up. The Economist writes “Iran’s exports tumbled from 2.5m barrels per day (bpd) in 2011 to 1.1m bpd three years later.”

A CNN report notes:

Eight countries would get temporary exemptions to the sanctions, because they had "made important moves to get to zero crude oil importations." Six of them will import Iranian crude oil at greatly reduced levels and two will completely end their imports, according to Secretary Pompeo. China, India and Turkey — among others — are still taking large volumes of Iranian oil.

The countries with exemptions are: China, India, Italy, Greece, Japan, South Korea, Taiwan and Turkey.

The Iran supply threat is becoming more muted by Saudi willingness to support supply shortfalls and the U.S.'s supply heft. The EIA also published monthly oil production data that showed August output surged by 2.1 million barrels a day year-over-year to a record 11.3 million barrels a day, notes the Wall Street Journal.

However, with prices dropping more recently, we could see U.S. producers moderate their efforts in the future. This obviously hasn’t shown up in the October to November shale area productivity reports. The EIA forecasts that U.S. crude oil production will average 11.8 million b/d in 2019.

Supply and consumption have been tracking closely. The following Dallas Fed projection is dated November 1.

About Occidental Petroleum

Oxy has shown conservatism and resilience as a producer and steward of capital. According to recent communiques, some key data points follow:

• Dividend yield ~4%, with excess cash from higher oil price realizations used for buybacks and balance sheet optimization; $887 million of share repurchases at third quarter.

• Consistent dividend growth over 16 years, 12% CAGR since 2002, appearing to stabilize. Oxy says their dividend is covered at WTI prices of $40.

• See the press release for third quarter earnings.

• Diversified streams of revenue: O&G production, midstream assets, chemical businesses, marketing/export capabilities (boasts higher capacity than any other E&Ps).

• Reasonable oil production growth, given their overall size: 5%-8% to 2022 estimated - Permian unconventional production at ~10% over 18 months as of September 2018.

Oxy is a low-cost oil producer with a deep Permian inventory and good execution. Their Permian shale production comprises roughly one-third of total production. Oxy suggests they have 17 years of inventory at break-evens of $50 WTI, according to the recent earnings presentation.

The firm holds a large Permian Basin footprint, plus Middle East and Colombian assets. They are expanding internationally and applying their learnings from Permian shale to their Oman assets. Oxy also is known to focus on managing decline rates, as oil is a naturally depleting resource. In a $60 WTI world, Oxy expects to present a favorable cash flow picture.

One concern related to oil producers is the shift to lower carbon energy sources. For years, Oxy has been a vocal supporter of efforts to reduce carbon emissions. As the largest oil producer in the Permian Basin, their attention to the energy transition is noteworthy.

The firm displays the following attributes:

• Acknowledges climate change and has a competitive advantage in the emerging field of carbon capture.

• Experienced in CO2-enhanced oil recovery (EOR), with 40 years of experience in the Permian and California, prior to divesting California Resources.

• Given the diversification of its asset base and business lines, it's positioned/positioning for transition which will still require fossil fuels for many, many decades.

Oxy uses a technique that harnesses carbon dioxide produced from power plants, forcing it back into aging oilfields. That boosts the pressure underground and drives more oil to the surface. “It is a process that Oxy has historically used in conventional oilfields, but is studying how to use in shale wells,” CEO Hollub says. This speaks to Oxy’s ability to lead in carbon capture innovations related to oil production but also produce more efficiently and effectively.

Other factors, however, weigh on the global economy with possible repercussions to demand. China’s slowing economy is a concern, but the U.S.-initiated tariff wars are another. According to Dallas Fed analysis from early October:

Concurrently, on Sept. 17, the U.S. imposed tariffs on $200 billion worth of Chinese goods, resulting in retaliatory tariffs on $60 billion of U.S. imports from China (Chart 1). U.S. trade policy is evolving rapidly but has not yet affected the International Monetary Fund’s World Economic Outlook forecast for 2.7 percent U.S. GDP growth in 2019.

How the tariff spat impacts prices of goods, changing supply chains, and shifting supply sources remains to be fully seen. Thus, energy investors need to monitor general economic conditions more carefully than over the last year even. The globally-connected economy’s influence will ultimately come home to roost in the U.S. After the election results settle in, Oxy is still a good hedge and play on real assets. Their ability to negotiate ever-changing oil market dynamics is impressive. It helps to have a large asset base in the Permian too.

Disclosure: I am/we are long OXY.

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.