2023-11-30 12:13:01 ET
Summary
- Occidental Petroleum Corporation's Anadarko acquisition faced challenges due to the pandemic, but the benefits were not completely canceled.
- The pandemic highlighted the risk of deleveraging after a leveraged acquisition, leading to a demand for low leverage ratios in future acquisitions.
- Technology advances have led to production improvements, which will impact earnings in the future. The Anadarko acquisition is becoming more valuable.
- This means that earnings are likely to grow in excess of any production growth announcements (if there are any material production growth announcements).
- As a result of this progress, the preferred stock redemption is likely to accelerate as company profitability increases.
Occidental Petroleum Corporation (OXY) had the misfortune of acquiring Anadarko before running smack into the COVID challenges. Nonetheless, despite the fears of many, the Anadarko acquisition now appears to be on its way to success. The pandemic challenges delayed that success. Fortunately, that pandemic did not cancel the benefits completely. Now technology improvements are making the deal even better.
The Pandemic challenges made the deal look very bad at first, when oil prices plunged before Occidental had time to deleverage. I had covered this strategy that Occidental used several times. The latest was when Cenovus ( CVE ) purchased the ConocoPhillip s ( COP ) partnership interest. The strategy often was executed without a hitch (as was the case with Cenovus) many times. But everyone always knew there was a risk of something like a pandemic challenge after an acquisition. The stock market and the debt market now demand a low leverage ratio under more conservative assumptions for any acquisition as a result.
Production Improvements
As investors, we really do not know all the benefits of the technological advances sweeping the industry. But every now and then management gives us a glimpse of the results.
Occidental Petroleum DJ Basin Well Performance Improvement History (Occidental Petroleum Earnings Conference Call Slides Third Quarter 2023)
Probably one of the more significant amounts of production that Anadarko had before the acquisition was the DJ Basin production. Therefore, the improvements in well production shown above will impact earnings in the future.
Investors need to keep in mind that the older production will still impact results. There may be some rework ideas available that can make the older production efficient. But the much lower per barrel costs that go with the improvements shown above will slowly take effect over time as enough of these wells come onto production to offset the more expensive older production. It will be a gradual transition that will be hard for investors to see in reported results. Clearly, the latest wells are far more profitable than is the case with earlier production (even if they cost more because that cost increase is very unlikely to offset the huge production improvement).
Keep in mind that the bidding as well as the market judgement about the final price of the acquisition was made with the lowest curve, shown above, in mind. Chances are very good that the latest improvements were not part of the original bargain. But the benefits will be available to Occidental shareholders.
Occidental Petroleum Best Well Performance Summary (Occidental Petroleum Earnings Conference Call Slides Third Quarter 2023)
The difference in this slide is that it includes the effect of "best inventory" as well as the well improvements. That "best" performance shown above currently has a way of becoming routine in the future.
While this shows the best possible outcome, this improvement filters down to bring more reserves onto the reserve report while adding more Tier 1 locations for future wells. These two items are benefits that were probably not a part of the final offering price a few years ago.
Technology continues to move so quickly that the cost to produce oil on the acquired properties is now a lot less than it was, simply because you get more reserves and more oil for each well drilled. Cost increases are not completely offsetting production increases.
Preferred Redemption Effect
I have a lot of comments or opinions that reflect the idea that if the current pace of redemption keeps up, it will be a very long time (if ever) before the preferred stock is gone.
Occidental Petroleum Preferred Stock Summary (Occidental Petroleum Third Quarter 2023, Earnings Presentation)
But the ongoing technological progress allows the company to become increasingly profitable at various prices of oil. Combine that with the ongoing industry consolidation and the market demand for dividends. The currently hostile market attitude towards growth rather than dividends assures decent oil prices for a long time to come.
In the past, speculative money poured in to pay fantastic prices for companies in the industry and fund projects that would likely not be funded by the industry itself. That is not happening because that speculative money got badly burned in the 2015-2020 period. It likely will not happen for some time to come.
This Means
Therefore, investors can likely expect the pace of preferred stock redemption to continue to accelerate. The pace of acceleration will be (mainly) controlled by technological advances and the price of oil and gas (and related products) for any given year. But without rapid (irresponsible) growth to bring about a cyclical drop to unsustainable lows, commodity prices are likely to help Occidental redeem the preferred stock at an increasing pace.
This is very different from maintaining the same slow pace over several years. Furthermore, Occidental gave us a view of the improving cost picture shown above, and that cost picture is improving at a fairly rapid pace.
The market is focused currently on the idea that the redemption of preferred stock is at a dismally slow pace. But then again, high prices that occurred in fiscal year 2022 rarely last long. The situation definitely helped Occidental retire a whole lot of debt. That really brought things back into balance for the company. Oftentimes, opportunities like that happen from time to time.
What management is trying to show investors is that despite the size of the company, better profitability lies ahead even if production does not grow.
A Side Issue: Permian Acreage Costs
Another big cost advantage Occidental has is in the cost of Permian acreage. Occidental was active in the Permian with an EOR operation long before there was any talk of unconventional opportunities. Occidental therefore had the chance to pick up unconventional acreage opportunities as needed before anyone else.
There is talk about Occidental acquiring closely held Permian Producer CrownRock. Given that Occidental has a premium acreage position already as one of the largest Permian operators, I personally do not think that Occidental is under any pressure to make another acquisition after the Anadarko acquisition. The company was financially stretched to make the Anadarko acquisition. I am not at all sure Occidental needs another big acquisition. Still, nothing would surprise me in this industry.
Compare this to many competitors that paid up to $3 million per drilling location. Not only does Occidental have some of the best acreage in the Permian, but it obtained that acreage at a fraction of the cost that later companies were willing to pay.
As technology advances, that acreage will likewise become more valuable. It is likely already more profitable without that per drilling location cost many later arrivals paid when they purchased acreage.
Conclusion
Management is now taking the time to put all the company's advantages together into one working piece where the market can see the advantages. As is typical for a large company with a large amount of established production, it will take some time for the market to see the improvements as cost reductions. But management is showing shareholders by way of the presentation that the lower cost process is underway, along with a campaign to continue to lower costs more.
That probably means that the profitability of the company under various commodity price scenarios will improve in excess of production growth for years to come.
Management wisely denied any more interest in acquisitions because the one that they made likely take all of their time and will for the next few years. The latest rumors about an acquisition, if it happens, will likely have greater benefits than the Anadarko acquisition by being obviously accretive right away. Right now, that does not appear to be a good possibility. But let us see what happens.
Occidental Petroleum Corporation stock remains a strong buy with the idea that technology improvements will continue for the foreseeable future. Those benefits should allow profitability to progress whether or not production grows.
The acquisition got off to a very rough start. But it now appears to be on track to perform as management originally envisioned. That would imply a lot more earnings power ahead along with a far better stock price in the future.
For further details see:
Occidental Petroleum: Why The Anadarko Deal Is Getting Better Over Time