Occidental Petroleum’s diversification strategy may pay off (NYSE:OXY) | Private Equity Weekly

Occidental Petroleum Corporation (NYSE: OXYThe company has made strides in positioning itself as a carbon-friendly oil producer as it further develops its full-cycle well enhancement technology through CO2 direct air capture and well enhancement EOR.as oil As the oil industry faces flat to declining oil markets in FY24 and easing production-related inflationary pressures, I believe Oxy is well-positioned to optimize wells through CO2 injection and its asset clustering strategy Production. I believe Oxy will achieve a strong turnaround and growth investments over the next few years through its planned deleveraging program, anticipated acquisition of CrownRock, subsequent resumption of its share buyback program, and enhanced oil recovery program. I have a Buy recommendation on OXY stock with a price target of $90.10 per share, equivalent to 6.08x eFY25 EV/aEBITDA.

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Like many international oil companies, Oxy is positioning itself to weather the storm effectively. By focusing production on longer-cycle assets, the oil market is expected to be flat to declining in FY24. During the Q4’23 earnings call, management found out that they would be focusing on adding a second drillship in the Gulf of Mexico to further develop their offshore assets. With WTI currently priced above $80/barrel, I believe this long-cycle strategy will alleviate some of the capital intensity of short-cycle unconventional production. Management forecasts that short-cycle and exploration capital investments will decrease by $320 in fiscal 2024, while mid-cycle investments will be budgeted to increase by $480. With its balanced portfolio, management expects a 65/35 shale/offshore production split once the CrownRock acquisition closes on February 24, 2024.

Oxy has spent much of the past 3 years building up its assets to bolster its long-term strategy. As of fiscal 2023, the company’s proven undeveloped reserves have almost doubled since 2020 to 1,232MMboe, and proven developed reserves have increased to 2,750MMboe, for a total proven reserves of 4Bboe. I believe that through strategic acquisitions, Oxy is working to improve its reserve valuations while maintaining discipline in its production growth. For fiscal 2024, management expects total production to grow 2%. This strategy should benefit Oxy in the long term as the company manages and enhances its assets for a better pricing environment. This can be seen in the company’s total reserve replacement ratio of 137% in fiscal 2023. Management expects to invest $5.8-6b in its energy and chemicals business in FY24, with a focus on mid-cycle assets. On top of this, Oxy plans to invest an additional $600 in its low-carbon venture and may receive additional investment from BlackRock.

Oxy’s production strength in the Rockies and DJ Basin assets was strong, while Permian production remained stable in 4Q23. The Rockies and its assets in Al Hosn will be the main focus for production growth in fiscal 2024 as the company reduces its Tier 1 assets in the Permian. I think Oxy’s plan to focus on lower wells could create some profit headwinds in the near term; however, this strategy will preserve the company’s senior assets for stronger oil markets when production strength can be better realized .

In the Permian Basin, management expects to maintain productivity during the current oil price cycle. Oxy is currently working to increase natural gas processing capabilities through the construction of new facilities in the Permian Basin, as well as EOR and direct air capture investments. Management mentioned that EOR and direct air capture may become operational in 2026, as they expect the DAC facility to be operational by mid-2025.

In the chemicals business, management expects PVC and caustics to face some near-term headwinds as pricing pressure in China remains unfavorable. Management expects OxyChem to generate earnings of $1-1.2b in FY24 EBT. Management expects to invest $700 in the chemicals business for the Battleground expansion and plant enhancement projects. Management expects construction of the Battleground facility to be completed by mid-2026. Upon completion, the combined EBITDA impact of the new facility and plant renovation projects will be an additional $300-$400 per year.

Forecasting financials, Oxy faces relatively flat or even declining markets in oil and gas as the global economy teeters between growth and recession.

use Strip prices published by CME as a guide, I expect oil prices to average between the mid-$70s and mid-$80s in fiscal 2024, and fall back to around $75/barrel in fiscal 2025. I also expect natural gas prices to recover slightly over the next few years as domestic dry gas production stalls. I do believe Oxy will continue to ramp up production to meet growing oil demand. Note that my eFY25 forecast includes an additional 170Mbbl/d from the CrownRock acquisition.

For eFY24, I do expect margin expansion as management guides for lower operating expenses per barrel in the next fiscal year; however, I expect margins to be slightly lower year-over-year in FY25 due to increased drilling activity and higher midstream costs compression.

Despite my bullish tone, there may be some downside risks worth considering. Oxy’s full-cycle CCUS project is still several years away and may not achieve expected recovery rates. Management also expects BlackRock to provide additional funding for its second DAC facility in Texas. BlackRock has ditched the ESG label Its ESG mutual funds have since collapsed. As more countries turn against ESG-oriented investingraising external capital may not be as simple as it once was.

Valuation and shareholder value

OXY stock currently trades at a slight discount to its IOC peers, at 5.90x EV/aEBITDA. I believe there is a lot of hidden value in OXY stock that is waiting to be unlocked as the company moves toward CCUS. I think the company needs to take some steps to deleverage its balance sheet before realizing a higher equity premium, as the company’s net debt far exceeds that of its domestic peers IOC (net debt/aEBITDA of 1.43x).

I do believe the company will have the capital flexibility to do so, especially after management cuts its stock repurchase program until CrownRock closes. This should free up some additional capital to pay down debt while maintaining an increased dividend rate of $0.88 per share. Given the multiple scenarios for OXY, I believe its stock price could experience some margin expansion in the coming years as the company cleans up its capital structure and moves toward decarbonizing its oil production process. I value OXY stock at $90.10 per share, equivalent to 6.08x eFY25 EV/aEBITDA, and give it a Buy recommendation.

I believe that for OXY stock to reach a blue sky scenario, oil prices would need to climb to the upper end of the $80-90/barrel range, which is likely to happen because OPEC+ maintains production cuts and Increase demand forecasting. The target scenario prices oil at the current strip price. The gray sky scenario means more pricing headwinds, with oil prices around $70.