Description

Overview

Occidental Petroleum shares offer investors an opportunity to own a high-quality O&G operator with substantial exposure to the Permian Basin (the highest quality patch of O&G assets in the US) for a meaningful discount to intrinsic value. I estimate that shares should be worth ~$100 by 2026 based on a 12x multiple on $8 - $8.50 of midcycle per share FCF. 

Strategic change 

The history of Occidental Petroleum is one of generally ineffective management and highly diversified operations. About a decade ago, Oxy made a meaningful strategy shift toward a focus on its core competencies. Specifically, Oxy set its eyes on the Permian Basin as the place to be and sold off low-margin oil and gas assets domestically and internationally to focus its efforts. 

The history of the Permian Basin provides some insights into its value. In the US, oil production topped out at 10,000 mbopd in the early 1970s and drifted down toward 5,000 mbopd by the early 2000s. At this point, the US was almost entirely reliant on production from conventional wells as the technology needed to reach and extract oil in unconventional deposits wasn’t yet economical. While oil reserves deep within the Permian were known, companies relied on vertical wells to extract oil from relatively shallow depths. This changed in the early 2010s as the technologies of unconventional horizontal drilling, long lateral wellbores, and improved fracking practices became economical, opening the doors for oil to be extracted from deeper shale wells and releasing the US of its reliance on foreign oil. Now, the US produces ~13,000 mbopd, with more than half coming from unconventional sources. These advancements paired with the Permian's innate natural makeup made it one of the lowest break-even (highest margin) oil fields in the US. The basin now accounts for ~30% of the US production and Oxy accounts for ~10% of the Permian’s production. 

The results of this shift toward core competencies can be seen through Oxy’s production results. From 2013 to 2023, Oxy’s mbopd production in the US swelled from 284 to 1000. Meanwhile, international production during that period remained flat from 227 to 222. Additionally, from 2013 to 2023, Oxy’s per barrel operating costs fell from $44.94 to $35.42, reducing break-even costs to under $40, and proved reserves expanded from 2,700 to 4,000 mboe. 

“We know we have more than 50 years of reserves remaining to be produced. In fact I think the Permian is going to be the last basin standing… just as the Permian will be the last Basin standing, Occidental will be the last company standing in the Permian.” - Vicki Hollub, CEO

Evidence of this change is also seen in the selection of Vicki Hollub as CEO in 2016. During her 40+ year career at the firm, Hollub served many management-level positions before being promoted to the top seat. Before her position as the CEO, she was in charge of Oxy’s Permian operations. During her tenure, Hollub’s track record has epitomized the spirit of this strategic shift. In 2017, Hollub made her intention to buy Anadarko, a prominent Permian producer, clear. Over the next two years, she approached their management more than six times, competed vigorously against Chevron, shrewdly structured financing, and ultimately made the unlikely acquisition happen. As part of that financing, she made a deal with Total S.A. to immediately dispose of Anadarko’s Algeria, Ghana, Mozambique, and South Africa assets upon closing, further highlighting Oxy’s intense focus on its areas of competence. Her vision for the future of Oxy included Anadarko’s Permian assets and she persisted in making that a reality. When the opportunity came to buy Oxy stock at a meaningful discount to intrinsic value in 2022 and 2023, she doubled and bought back 8% of the shares outstanding. Her recent efforts to purchase CrownRock, a strong player within the Permian’s Midland Basin, further exemplify that focus. As a first-time CEO with an opportunistic and focused strategy, she has qualities that resemble that of an “outsider” CEO as described by William Thorndike.

Doubling down on the Permian makes sense for Oxy because they have developed technical expertise in subsurface modeling and enhanced oil recovery that give them advantages in mapping, extracting, and recovering oil. They have grown particularly strong at subsurface modeling within the Permian and used this to unlock extra value out of Anadarko. Without this technical ability, the Anadarko acquisition’s economics wouldn’t have worked - they were betting on their proprietary know-how to make that acquisition work. Secondly, Oxy’s bread and butter technique to squeeze industry-leading amounts of hydrocarbons out of their wells is their CO2-enhanced oil recovery technique. Oxy has worked to master a process of injecting CO2 into reservoirs which in turn expands the oil molecules, lowers the viscosity, and unlocks trapped oil. For context, in a conventional reservoir, without enhanced oil recovery, they can get 35 - 40% of the oil out. With enhanced oil recovery, they can get 75 - 80%. In shale, enhanced oil recovery can increase recoveries from 10% to 18%. Oxy has been able to obtain this CO2 from their carbon capture operations and sequester it during this process, leading to net carbon-neutral oil which is favored by maritime and jet operators. The combination of high-quality assets, excellent subsurface-level modeling, and enhanced oil recovery have made Oxy the strongest operator in the Permian. This quality can be see in in Oxy’s continuous improvement in top-tier well performance and industry-leading cumulative oil production over 6-month and 12-month periods in the Delaware Basin:

Valuation

Oxy’s valuation is on the low end of its peer group. 

With ~$13B in EBITDA in 2023 and ~$27B in debt + BRKs preferred equity, Oxy is reasonably leveraged at the moment. However, assuming the CrownRock deal goes through, debt + preferred equity would increase by $9.1B to ~$36B. While Oxy intends to pay down this debt rapidly with divestitures, current cash flow, and increased cash flow from the CrownRock assets, I imagine the extra risk relative to peers is suppressing the current valuation. 

Oxy’s primary objective for the next 24 - 36 months is to aggressively pay down debt from ~$29B to $15B using a combination of $4.5 - $6B in divestitures and excess cash flows. This seems like a reasonable target if oil prices remain above $65/barrel. Thereafter, Oxy intends to use excess cash flow to redeem BRKs preferred equity and opportunistically buy back stock and pay down debt. 

By 2026, once the CrownRock acquisition is integrated and OXY's debt burden has been reduced, OXY should be able to produce $8 - $8.50 of midcycle ($75 oil, $25 ngl, and $2 gas) FCF. At 12x FCF (conservatively relative to their peers), shares should be worth ~$100 by 2026. 

Risks

Oil prices are the most important risk as a fixed cost basis creates high operating leverage. Pairing this with Oxy’s relatively high financial leverage creates a meaningful risk if oil prices drop to below $40/barrel for a sustained period. In the short term, I have no strong opinion on the direction of oil prices but the consensus seems to be that we are living in a world of $70 - $80 midcycle oil prices and I have found no reason to disagree with that. In the very long term (20 - 30 years), my research suggests that the combination of supply scarcity, persistent demand due to feedstock usage, and inflationary factors should make oil worth meaningfully more than it is today on a per-barrel basis.

While the CrownRock deal falling through may seem like a risk, my research suggests that very unlikely. If that were to happen, I estimate Oxy would still be worth ~100/share as they'd probably very aggressively pay down debt and buyback stock.

Catalyst

• Debt paydown
• Opportunistic buybacks
• FCF increases