Occidental Petroleum's Opposition To The Carbon Tax Is A Risk
Summary
- Occidental Petroleum has recently announced that it's opposed to the carbon tax in contrast to other massive oil companies.
- This is a risk for the company - expensive, but certain regulation is much easier to work around than uncertain regulation.
- We expect the company to use its impressive asset portfolio to generate strong cash flow and shareholder rewards.
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Occidental Petroleum's (NYSE:OXY) CEO recently came out in opposition of a carbon tax in rejection of the view of other large U.S. companies. This opposition and the general potential disagreement over a strong regulatory framework puts more uncertainty in the oil markets. As we'll see, climate change is a strong risk facing the markets besides their potential. Despite this risk however, Occidental Petroleum is a strong investment opportunity.
Climate Change and Uncertainty
The vast majority of climate scientists agree that climate change is real. Numerous U.S. government studies along with other research show that climate change has numerous effects on the environment. However, research into the best way to handle it, including the "Green New Deal" and other plans, remains much more open ended.
In our view, regulation is forthcoming. Fundamentally, the tragedy of the commons is an understood scientific flaw - and it eventually needs to be distributed. Regardless of your view on the best way to solve climate change, this is forthcoming. The carbon tax represented a clear, understandable, and financially manageable format for this.
Going against the carbon tax, or having a proposal that's not fully agreed upon by the industry, means the uncertainty for additional regulation that can be much more expensive for the company. There are many proposals out there that could be significantly more expensive for oil companies than a carbon tax.
Occidental Petroleum Asset Base
Despite this, Occidental Petroleum has an impressive asset base from which it's generating substantial FCF.
Occidental Petroleum Asset Base - Occidental Petroleum Investor Presentation
Occidental Petroleum's new sustaining capital of $2.9 billion annualized has allowed the company to maintain FY production at expected rates of 1.14 million barrels/day. The company is one of the lowest cost producers in the Permian and has an impressive asset base with 22% base decline for 2021 to continue producing.
In the Permian Basin, where wells decline incredibly fast, the company's base declines have been relatively slower. The strength of the company's asset base is also used from the fact that its sustaining capital is just $7/barrel. The company's 2021 domestic operating costs are at $6.7/barrel with transportation costs at $3.8/barrel.
Occidental Petroleum Cash Flow
Occidental Petroleum will be able to use this asset base for strong cash flow and drive strong shareholder rewards. The company's cash flow goes up by $215 million/dollar improvement in crude prices. Crude prices are currently ~$63/barrel (Brent), so versus $40/barrel that means ~$5 billion in cash flow improvements.
In 4Q 2020, Occidental Petroleum generated $0.8 billion in FCF. That was a quarter when prices averaged $44/barrel. Based on the same numbers, and roughly constant capex, at $60/barrel (WTI), the company's average quarterly cash flow is ~$1.6 billion. For a $24 billion company, that's massive cash flow that the company will be able to use to drive strong shareholder rewards.
The company has significant debt worth paying close attention to. After maintaining production bases, the company has focused on aggressively paying down debt. It also has its outstanding preferred shares with Warren Buffett.
Occidental Petroleum Risk
Occidental Petroleum's risk is oil prices. The company's quarterly free cash flow potential is ~$1.6 billion at current oil prices; however, at $28/barrel, the company's FCF hits $0. That's because it needs to continue investing its sustaining capital for developing its assets and pay the actual cost of pulling the oil out of the ground. That all has cost for the company.
Conclusion
Occidental Petroleum has become one of the first major oil companies to go against a carbon tax, versus other major U.S. oil companies. That adds significant unpredictability to investing in the oil markets. However, despite this unpredictability, the company is still exciting with an impressive asset base.
Going forward, we expect the company to maintain its low lifting cost and continue to invest its sustaining capital. These investments will allow the company to grow and generate more than $6 billion in annual FCF. That's incredibly strong FCF, and versus the company's market cap, it'll enable the company to generate strong shareholder rewards.
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