California Resources Corporation

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 2/5

California Resources Corporation (CRC) is an independent oil and natural gas exploration and production company primarily operating in California. They are also developing Carbon Capture and Storage (CCS) projects, aiming to address emissions related to their operations.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

California Resources Corporation (CRC), formerly Occidental Petroleum Corporation, is an independent energy and carbon management company.

Business Overview

  • Revenue Distribution: CRC’s revenue is heavily influenced by commodity prices, mainly oil and natural gas sales. While they engage in certain oil trading, they prioritize selling their production directly to customers. They also generate revenue from carbon management initiatives.
  • Industry Trends: The oil and gas industry is subject to high commodity price volatility, which can greatly impact revenue and profitability. Emerging trends include the energy transition, carbon capture and storage technology, and the push towards lower-carbon solutions. This will require significant adaptation in the oil and gas industry for long-term success. The company is also facing increased regulatory scrutiny, especially in California.

  • Margins: The recent earnings report reveals a strong operating margin of 39%, which would mean the business should have pricing power and a cost advantage, but a review of the underlying costs and assets of the company indicates otherwise.

    • Net oil and natural gas production for the three months ended September 30, 2024 was 78 Mboe/d, with oil, and NGL’s averaging about 38 Mboe/d. Natural gas accounted for about 40 Mboe/d.
    • Revenues were reported as $604 million for the three months ended September 30, 2024.
    • Operating expenses for the three months ended September 30, 2024, were $169 million.
    • Non-operating expenses were reported as $266 million for the three months ended September 30, 2024.
    • Effective tax rates from domestic and foreign taxes are roughly 25.9% for the period.
    • Net loss of $127 million was reported for the period with EPS of ($0.30)
  • Competitive Landscape: The oil and gas industry in California is competitive, but CRC has strategic advantages through concentrated acreage in major oil and gas basins. However, they face competition from diversified multinational companies and smaller, more efficient, energy firms.
  • What Makes CRC Different: CRC is unique in that it’s not only an oil and natural gas producer but also actively engages in carbon capture, utilization, and sequestration (CCUS). These carbon management operations provide a new angle for value generation and can be considered a forward looking and innovative approach to energy production.

Financials

  • Revenue Streams: Revenues derive from sales of oil, natural gas, and NGLs, and from carbon management projects. The reliance on commodity sales means they are susceptible to price volatility and general market downturns.
  • Profitability: Despite the recent quarter which reported a net loss, gross profit and operating margins were relatively high in the past, before debt servicing, showing an underlying operational profitability.
  • Operating Expenses: Operating expenses are primarily related to production, transportation, and processing costs. These numbers may vary based on production volume and operational efficiency.
  • Capital Expenditures: CRC is a capital intensive business with expenses related to drilling, developing, and maintaining production assets. Capital expenditures will significantly fluctuate as new production assets are acquired and developed.
  • Debt: CRC carries a large debt load ($3.1 billion), mostly through secured instruments, including a revolving credit facility. The credit facility has been significantly increased lately to meet the needs of its carbon management business. As such, the company is highly leveraged.
  • Liquidity:
    • Available Cash and Cash Equivalents: $463 million.
    • Availability of Credit: $470 million
    • Liquidity Total = $933 million
  • Share Repurchases: CRC repurchased shares worth $46.7 million during the three months ended September 30, 2024 and have spent approximately $740 million on share repurchases between May 2021 and September 30, 2024.
  • Dividends: The company pays a small quarterly dividend of $0.31 per share.

CRC stated that it believes its long-term strategy for both its oil and gas business and its carbon management efforts, will enable the Company to generate shareholder value and increase the sustainability of its operations.

Moat Assessment:

  • Moat Rating: 2 / 5
    • Intangible Assets: CRC has a recognized brand among California energy producers. However, this recognition doesn’t grant pricing power or customer loyalty in a commodity-based industry. They also have some patents for CCS, but those are not proven yet.
  • Switching Costs: These are negligible due to the commoditized nature of oil and gas, it can be easily substituted. There are no such things as switching costs for the buyer. * Network Effects: None. No network effects are present in oil and gas exploration and production. * Cost Advantages: They do hold large areas of California’s most oil rich basins which gives them economies of scale due to geographic advantage. However, many players are in the same area, and a cost advantage here is not as strong, or not as wide as a competitive advantage should be. * Therefore, CRC has some small economic moats but they are not particularly sustainable, because they are not a monopoly in their product, and has other competitors in the region.

Risks to the Moat and Business Resilience:

  • Price Volatility: The company’s revenue and profitability are directly exposed to fluctuations in oil and natural gas prices.
  • Regulatory Changes: Stringent environmental regulations, particularly in California, could significantly raise operating costs or even limit production.
  • Technological Disruption: While CRC is actively investing in carbon management solutions, those technologies are still developing, meaning they may fail. Competitors may also develop better technologies rendering their R&D obsolete. They also risk losing market share due to newer, better competitors.
  • Operational Risks: The company is subject to operational risks including well failures, geological uncertainties, accidents, and natural disasters-which could cause serious losses in their finances and profits.
  • Capital Intensity: Being a capital-intensive business, it requires significant ongoing investments to maintain current production levels, and to develop new ones, making it vulnerable in cases of economic depression.
  • Debt Servicing: The large debt burden increases their financial risk and makes it harder to be resilient during downturns.
  • Political Factors: Government energy policies and political events can drastically change demand and prices for oil and natural gas.
  • Reliance on Hedging: The company uses hedges to mitigate pricing volatility, which could limit profits if prices rise significantly
  • Aero Merger Integration: Integrating the Aero Merger and any additional acquisitions or divestitures may negatively affect their operations

There can be no guarantee that they will be able to successfully develop, implement, and monitor its carbon management projects. Moreover, future legislation and regulation related to these projects are difficult to anticipate accurately and may result in additional cost or delays, or even halt the projects.

Understandability Rating: 3 / 5

  • While the basic business of oil and gas exploration is relatively straightforward, the complexity lies in understanding the financial instruments, the effects of commodity price swings, and carbon regulations. Added carbon capture and storage adds a whole new layer of complexity to a relatively simple business. While they are more aligned to an ESG business model, their oil and gas business is still dependent on commodity markets, making their performance volatile.

    • I am reducing their rating for the lack of clarity in their financials and their reliance on a very complicated and dynamic market.

Balance Sheet Health: 2 / 5

  • The company is laden with a large amount of debt and negative equity.
  • They have had good profitability in the recent past due to prices rising in commodity markets, but is not enough to offset their current debt burden.
  • They do have sufficient liquidity to meet immediate obligations, but debt reduction remains the main priority for the company

CRC is currently undertaking major strategic transitions from being a traditional oil and gas explorer to being a diversified company that also does carbon sequestration. How the company transitions into the new market will decide their future.

In conclusion, while CRC does have some advantages in its specific niche, they are not strong enough to constitute a moat. The company is exposed to a wide range of risks, most of which are not predictable, making it risky to value and invest. The company has poor balance sheet health, with high amounts of debt, and will need to improve their liquidity. Therefore, the business might have the potential to build sustainable operations but this is far from guaranteed.