Occidental Petroleum - As Oil Approaches $40 WTI, Don't Miss Out

Summary

• As WTI price approaches $40, we're approaching the level where Occidental Petroleum can maintain production and a 20% dividend.
• The company has managed to drastically reduce its costs, meaning its actual breakeven is much lower. It doesn't need to roll over debt.
• Current WTI prices aren't sustainable and there's room for a significant recovery in prices from this point.
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Occidental Petroleum (NYSE:OXY) is a near $14 billion oil company that has lost more than $50 billion of market capitalization. The company, when it originally acquired Anadarko Petroleum, said that it needed $40 WTI to support its dividend, which would be more than 20% given its current share price. Unfortunately, the collapse in oil prices below this level forced the company to cut its dividends as investors worried about its debt.

As oil prices recover significantly, more than doubling over the past 2.5 months, they have rapidly gone back near the $40 WTI threshold. Now they're within 10% of the $40 WTI threshold. At the same time, the company has cut its dividend by near 98%. That means that Occidental Petroleum is in a better financial position today than it would be at $40 WTI.

Occidental Petroleum - The Business Journals

$40 WTI

Occidental Petroleum, before the collapse in oil prices, drew $40 WTI as the line in the sand to support its expenses.

Occidental Petroleum Excess Cash Flow - Occidental Petroleum Investor Presentation

Occidental Petroleum originally highlighted this cash generation ability, which highlights the strength of the company's low-cost asset place. At $40 WTI, the company would be able to pay its 20% dividend yield, and keep production flat with $3.9 billion of capital spending. Going toward $50 WTI, the company would adopt 5% growth at $6.6 capex and $1 billion in excess cash.

Traveling all the way out towards $70 WTI the company would have 5% growth at $6.6 capital expenditures. That would come, in addition, with nearly $6 billion in excess cash after generation. Relative to the company's current market capitalization, that would mean a 20% dividend and a more than 40% cash flow yield on top of that.

More importantly, that would make the company's debt in the $10s of billions much more manageable.

COVID-19 Spending

However, the significant aspect worth paying attention to here is two-fold. First, to make our math simple, Occidental Petroleum produces roughly 500 million barrels/year of oil production. Second, Occidental Petroleum has drastically cut spending plans from even its above plans over the past several months as a result of COVID-19.

Occidental Petroleum Press Release - Occidental Petroleum

Occidental Petroleum has made a number of moves to reduce costs. Specifically, the company has reduced operating and exploration overhead by roughly $500 million in addition to previously announced $1.1 billion in cost reductions. The company has also announced it would cut its capital spending from $5.3 billion to $2.8 billion, a $2.5 billion reduction.

At the same time, Occidental Petroleum has announced that it is cutting its dividend to basically $0, a $2.8 billion annualized reduction. The company's net reduction in costs from these actions is roughly $6 billion or $12/barrel the company produces. That means, looking at the company's 2021 cash flow generation announcement above, the company's actual cash flow breakeven after dividend is roughly $28 WTI.

That means that, at current WTI prices, Occidental Petroleum should earn roughly $5 billion in 2021 cash flow. In 2020, the company's hedged production will provide an extra billion over 2020. It's important to keep in mind that this is on the basis of no recovery in WTI prices from today's levels.

Debt

Occidental Petroleum's cash flow generation, as we discussed above, means that the company's debt profile that investors panic about is actually manageable.

Occidental Petroleum Debt Maturities - Occidental Petroleum Investor Presentation

Occidental Petroleum's debt maturities that it needs to worry about are $6.4 billion in debt due 2021 and $4.7 billion in debt due 2022, with no debt due in 2020. It currently has $5 billion in a credit facility with $1 billion in cash and cash equivalents. The company also has a number of levers it can pull - it has chosen to pay Warren Buffett in shares to save $800 million annually.

So let's take a 5-year outlook from 2020-2024, assuming the company issues equity to Warren Buffett the entire time. That's $4 billion in the company's expenses that'll be saved. We'll ignore the credit facility and add $1 billion in cash and cash equivalents. We'll also assume WTI stays at $36 for the next 5 years - an incredibly abnormally low price.

Based on the company's small dividend, the company will get $4 billion in net cash flow annually. We will subtract $1 billion from this to allow for an increase in capital expenditures to maintain production instead of the 6% production drop expected this year. This means $20 billion ($25 billion cash - $5 billion higher capex) in net cash generated.

Over this 5-year period, the company has $16.2 billion in debt due. That means the company has $3.8 billion in cash leftover. That'd nearly cover 2025-2026 debt for the company should it choose to do so. Of course, the shareholder rewards over this 5-year period, during an abnormally low WTI period, would be minimal.

However, the company's debt and financial position would be much stronger. The company's interest payments would be more than $1 billion lower annually. The company would be much better positioned to generate strong financial results in the future. Putting this all together and we can see how, even in a low oil price, with no rollover, the company's financial position is manageable.

We believe the company's low-cost asset base will actually set up the company well to generate incredible shareholder rewards for those willing to invest for the long run.

Risk

Occidental Petroleum's risk from all of this is quite clear. It's that oil prices could remain lower for significantly longer than expected. COVID-19 has clearly shown that oil prices can remain lower for longer. As we discussed that a $36 WTI could position the company well for the long run, $20 WTI could destroy the company.

Oil Breakeven Price - The Economist

Of course we can't predict oil prices, however, as we can see above, $36-40 WTI clearly aren't sustainable WTI prices to support global production. The supply and demand imbalance means that this imbalance in prices will quickly resolve itself. This breakeven means that we can expect WTI prices to rebound past $40 WTI if not higher.

Conclusion

As investors continue to panic about Occidental Petroleum's debt load, WTI crude oil prices have slowly crept back to the level that makes the company's old dividends sustainable. At the same time, the company has made a number of moves to drastically reduce its expenses, meaning that the company's $40 WTI breakeven is actually much lower now.

Occidental Petroleum has the financial strength to handle its debt maturities. In the worst-case scenario, that effort will mean that the company can reward shareholders by converting debt to shareholder equity. But it also highlights the strength of the company's low-cost asset base in the event of a price recovery. That could mean strong rewards.

Analyst’s 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.