I wrote a “BUY” for Occidental Petroleum (OXY, Financial) about two months back and since then the stock has dropped about 9%. The stock will move higher in the long term, primarily because of the company’s core assets and key growth drivers.
Occidental Petroleum is involved in the acquisition, exploration and development of oil and gas in the U.S. and internationally. The company operates in three segments: Oil & Gas, Chemicals and Midstream and Marketing. I discussed the company’s operation in my earlier article so I will not discuss it further. To put things in perspective, the company’s chemical operation has been a life saver during tight oil price markets, and its increasing acreage operations in the Permian Basin will help it increase production at a low cost.
Performance in fiscal 2016
In fiscal 2016 Occidental Petroleum exceeded its total production growth guidance and increased its production from 565mboed in fiscal 2015 to 602mboed. Similarly, production in the Permian Basin increased approximately 13% year over year to 124mboed.
In addition, the company has also been able to achieve its goal of decreasing the total cost per barrel of oil equivalent produced. Operational efficiency was important especially because of the sharp decline in commodity prices. This has helped in both improved margins and free cash flow.
For fiscal 2016, total company reserve replacement ratio of 189% has been impressive with the Permian Basin reserve replacement ratio being 290%. For 2015 the company had total reserves of 2,200mmboe with new addition of 346mmboe through revision of new estimates and improved recovery. Further, 91mmboe was added through acquisitions and sales with a depletion of 231mmboe through production resulting in 2,406mmboe of reserves at the end of fiscal 2016. Approximately 77% of the reserves were proved developed, and 74% were liquids. Thus, 150% of organic reserve replacement ratio looks healthy, and the company is in a good position to both increase its production and control cost to offer better margins in fiscal 2017.
Middle East operations
Occidental Petroleum has been actively involved in the Middle East for the past four decades. The Middle East region represents 46% of the company’s total production with operations in Qatar, Oman and the United Arab Emirates. Fiscal 2016 resulted in record production in Oman and the United Arab Emirates. In Oman the company produced 96mboed through multiple onshore projects utilizing enhanced oil recovery (EOR) whereas in Qatar 108mboed were produced through multiple shallow water EOR projects.
The Al Hosn gas project in the United Arab Emirates is expected to be the next stepping stone in the company’s production performance. The company expects to increase the plant capacity to 110%, which would increase the production to over 70mboed in fiscal 2017. The company aims to improve production and also cut down cost in both Al-Hosn gas and Oman, which would help it increase free cash flow by another $300 million.
Permian Basin to boost productivity
Permian Resources production doubled from 2013 to 2016, and the company expects it to double again in the next four years at a moderate commodity price level. This is achievable primarily because the company is geographically focused with an aim to improve operations in its core areas. With approximately 650,000 net acres in the Delaware and Midland basins and around 300,000 net acres associated with 11,650 wells in unconventional development inventory, the company has significant acreage and growth potential in the region. Considering a deep inventory in the basin and an infrastructure that supports growth, the company estimates 30% CAGR in the next three years.
The company has been able to cut its production cost in the Permian Basin by more than 25% in fiscal years 2016 and 2017. The company aims at further reducing its cost by focusing on design and efficiency. Thus, improved production and declining production cost would drive better margins for Occidental.
Fiscal 2017 outlook
For fiscal 2017 Occidental Petroleum expects to spend $3.0 billion to $3.6 billion toward maintenance and growth. With $1.0 billion to $1.4 billion spending in Permian Resources, the company expects to increase drilling in Southeast New Mexico and Greater Barilla Draw. Thus, a flexible capital program is designed to invest where the company has the highest return and opportunities for growth. It is based on these strategic investments that the company aims at increasing its production by 4% to 7% in fiscal 2017.
Cash flow is also expected to improve in fiscal 2017 with improved product prices and chemical performance. The company expects cash flow changes of approximately $100 million for $1 per barrel change in oil prices and approximately $45 million for 50 cents per mmbtu change in natural gas prices. Occidental Petroleum expects additional free cash flow generation of $400 million in oil and gas operations, $150 million to $200 million in the midstream segment due to better marketing economics and $400 million from the chemical segment. This would increase the total fee cash flow generation by $950 million to $1 billion in fiscal 2017. An increase in free cash flow would favor shareholder wealth creation through better dividend payouts and share repurchases.
Conclusion
Oil cartel OPEC and non-OPEC member nations have agreed to cut production by 1.8 million barrels per day during the first half of fiscal 2017. This would further boost oil prices which would help Occidental Petroleum increase cash flow and improve margins.
Considering that the company operates in the low-cost Permian Basin and has megareserves in Middle East, Occidental will benefit with improving oil industry dynamics and can be considered a good long-term investment.
Disclosure: No positions in the stock discussed.
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