Occidental Petroleum Corporation

Moat: 2.5/5

Understandability: 3/5

Balance Sheet Health: 3/5

Occidental Petroleum (OXY) is an international oil and gas exploration and production company. It engages in operations across three business segments: Oil and Gas, Chemical and Midstream & Marketing. It operates in the United States, the Middle East, and Africa.

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.

Business Overview

OXY is a large player in the energy industry with integrated operations and a diverse portfolio of assets across three segments.

  • Oil and Gas: This segment focuses on exploration, development, and production of oil and natural gas. It includes operations in the Permian Basin, one of the world’s largest and most productive oil basins, as well as other areas in the US, Middle East, and Africa. The revenue and profits generated by this segment are highly dependent on commodity prices, especially oil and NGL prices.
  • Chemical: OXY’s chemical division (OxyChem) is the largest North American producer of PVC resins, chlorine, and caustic soda. These products are sold to many industries, including those that make plastics and pulp and paper. OxyChem generally has a low production cost.
  • Midstream and Marketing: This segment includes midstream assets, such as pipelines and storage tanks for oil and gas, as well as crude oil and natural gas marketing operations. It allows OXY to distribute and market its products, but its performance is also highly correlated to commodity prices.

Industry Analysis

The energy sector is highly cyclical with significant volatility in prices based on global economic conditions, weather, geopolitical instability, and geopolitical uncertainty.

  • Oil and Gas: Oil and gas prices remain highly sensitive to supply and demand dynamics, geopolitical risks, inflation, and global growth. The company’s profitability is affected by short and long-term changes in these factors. Over the last few years we have seen higher commodity prices caused primarily by the war in Ukraine and general inflation. On the other hand, if a supply glut arrives, oil prices can drastically fall.

  • Competition: Exploration and production companies face stiff competition, though many are larger than OXY. These companies compete on cost and efficiency of operations. There have also been multiple mergers and acquisitions among energy companies.
  • Opportunities: Companies that can lower their production costs, or produce more oil and gas while keeping capital costs down have a competitive advantage. Carbon capture, utilization, and storage (CCUS) is also a major investment area for many companies, as it also gives a green image. The Permian basin has a low break-even price of oil due to the high productivity of the area, giving companies there an advantage.
  • Chemicals: The chemical market is impacted by supply, demand, the price of inputs like natural gas, and import/export dynamics. However, OxyChem has a highly specialized product portfolio which offers it a slight moat.
  • Competition: Major chemical companies face fierce competition on commoditized products, especially from overseas suppliers with low labor costs. Demand for chemicals is closely tied to the global economic outlook.
  • Opportunities: High-margin speciality chemical businesses with lower costs of operations are better placed for success.
  • Midstream and Marketing: The midstream business is fairly predictable since contracts for distribution often generate stable cash flows, but marketing is more sensitive to commodity prices.
  • Competition: The midstream business often functions as regional monopolies and competition is limited. Marketing, on the other hand, is highly competitive with multiple traders active in the market.
  • Opportunities: Midstream businesses can increase value by building out new pipelines, or increasing efficiency.

Financials

Recent financial results are strong primarily due to high prices of oil and gas and the benefits of OXY’s recent acquisition of CrownRock L.P. Here’s an analysis of OXY’s financials using the most recent 10-Q (Quarterly Report) released on November 2024.

  • Revenue: In the nine months ended September 30, 2024 OXY’s total revenues have increased from $19.7 billion to $21.1 billion as a result of better prices and higher production volumes in oil and gas. However, the chemical revenue decreased from $4.7 billion to $4.3 billion because of lower demand and prices.
  • Profitability: Operating income for the first nine months of 2024 increased from $3.3 billion to $5.2 billion. The profitability of oil and gas is heavily dependent on oil and gas prices. Higher prices cause profits to surge, and vice-versa. The midstream and marketing and chemical segments, on the other hand, are less volatile. Also, note that nonrecurring gains and losses can have a major impact on OXY’s profits.
  • Return on Invested Capital (ROIC): Return on invested capital (ROIC) can be seen as a measure of how efficiently the company uses its capital to generate profit. However, it is not mentioned as a separate line item. ROIC data from Morgan Stanley show that OXY’s adjusted ROIC for the 2003-2023 was mostly negative, indicating difficulty in value creation for the company. This should be taken with a grain of salt since different analysts may calculate ROIC differently.
  • Earnings per share (EPS): EPS also saw a huge increase from $2.83 to $3.14 as a result of better performance in all segments. The adjusted EPS has even increased more from $1.62 to $3.69.
  • Leverage: OXY has a significant amount of debt and is aggressively working to pay it down. A decrease in debt level improves a company’s ability to obtain funding and survive during down cycles.
  • Cash Flow: OXY has a solid operating cash flow and continues to have considerable positive FCF even with high capex requirements.

Moat Assessment

OXY has certain advantages, but it also faces significant challenges, leading to a moat rating of 2.5 / 5.

  • Intangible Assets: OXY benefits from its brand and reputation. The company has been in business for 104 years. It has also earned its technical and engineering expertise for oil and gas production through large-scale operations. However, OXY’s brand is nowhere near as strong as the brand of Apple, Coke, etc. Also, its expertise can be replicated by other companies. Thus, this does not constitute a durable moat.
  • Cost Advantages: OXY is a low-cost producer in some areas like the Permian Basin, due to economies of scale and favorable geographical factors. But their costs can be severely impacted by oil price fluctuations. Chemical operations are the most important for OXY in the low cost area, given their large scale, but this is also vulnerable to commoditization. Overall, OXY has moderate cost advantages, but they are not sufficient to constitute a strong moat.
  • Switching costs: Switching costs in the oil and gas business are very low because they are commodities. However, in the chemical and midstream business, the services can be relatively sticky. Yet it is not a strong moat.
  • Network effects: There is little or no network effect in the businesses that OXY operates.

Moat Risks & Business Resilience

There are many risks that can affect OXY’s moat. The biggest of them is the fluctuation in oil and gas prices as a result of global economic conditions, geopolitical risks, and supply/demand imbalances. Other factors:

  • Technological Disruption: OXY has been working on carbon capture technologies. These initiatives are costly and require large R&D investments and they may or may not be successful. Lack of innovation might make the company less competitive.
  • Regulatory Risks: New regulatory changes relating to environmental concerns, carbon capture, and emissions can also impact the company by way of additional costs.
  • Dependence on Acquisitions: OXY’s growth strategy depends a lot on big acquisitions. These integrations can be costly, and benefits may not materialize.
  • Environmental Incidents: OXY may encounter oil spills, chemical leaks, or other environmental accidents that could lead to litigation, fines, and operational disruptions, harming reputation and financial performance.
  • Global Economic Conditions: Slow or negative global economic growth can impact the demand for oil, gas, and chemicals, which would affect OXY’s profitability, even with the best management, assets, and structure.

Despite facing the above risks, OXY has shown to be quite resilient to financial shocks as evident in previous years, during the periods when there were volatile energy prices. It has a history of surviving during tough times, thanks to its scale, access to resources, and management expertise.

Understandability

OXY is moderately complex to understand, rating it 3 / 5. Its operations are spread across multiple segments and geographies which makes it difficult to analyze them together. Also, the factors that impact the commodity markets are complex and often not known ahead of time. In addition, OXY is also starting many new initiatives for low carbon energy, the results of which are still unknown.

Balance Sheet Health

OXY’s balance sheet is moderately healthy, giving it a rating of 3 / 5. The company has improved its debt picture by paying off a lot of debt, but still carries a large debt burden. Also, OXY has been selling off assets that it considers as non-core. However, these moves are still not enough to completely mitigate the risks of a downturn in the energy industry. Its goodwill remains at a level of around $30 billion, which can be an impairment risk.

The company’s recent cash generation is fantastic, so it has the flexibility to continue deleveraging its balance sheet.

Recent Concerns

OXY has been under criticism over its deal with CrownRock, a Permian basin driller. Many investors don’t seem to like that OXY is buying at peak prices. Also, they see OXY making a big bet when debt is still very high. As per the earnings calls, management has defended the acquisition, saying that the Permian basin assets are extremely profitable and this deal will immediately add to OXY’s earnings. Also, management believes that they can drive more production from the assets, and reduce costs, which should eventually reduce debt. Also, OXY is still working to improve its operational efficiency, reduce emissions and develop new technologies.

Conclusion

Oxy has a reasonable moat at 2.5 out of 5, but that can be affected by technological change, volatility in prices, regulatory risks, and other such factors. Understanding OXY requires some effort, and its balance sheet could be better. However, management is taking the right steps to improve efficiency and increase shareholder value.