We have been trawling various YouTube channels discussing Occidental Petroleum and finally, (after cleaning our room and attending Sunday Service online), we got down to the gritty details of forming a financial projection on Occidental Petroleum. We just focused on the US upstream portion of things in order to get a conservative estimate of the likelihood of Occidental filing for Chapter 11. All other segments of Oxy are expected to break even , but this is still a work in progress so we may update it after looking at the midstream segment and Oxy’s Chemical Manufacturing business. But the conclusion of this analysis has already given some confidence that Oxy has a better than 50-50 shot of surviving , at the expense of their bankster friends. However, this does not mean that we expect the stock to appreciate. Instead we expect it to trade at the price of a 1 year out of the money call option on WTI at strike price of $40 aka at GE stock pricing.
The key to Oxy’s profitability is the cost of extracting 1 BOE, or Barrel of Oil Equivalent vs the price it receives for a BOE extracted. Currently at $17 WTI, its operating margin for this core activity is -200% or Oxy loses $21 per Barrel of Oil Equivalent produced. The cash component is somewhat lower , Oxy loses $5 per Barrel of Oil Equivalent produced. However , if WTI futures drop further to under $10, Oxy could lose on a cash basis, $15 per Barrel of oil Equivalent produced. Simply stopping production to 0 is not so simple. Each well needs to be capped and sealed, which could cost $1M to $2M per well. In some cases, the entire well asset is destroyed and it may cost up to $4 to $5M to reactivate the well in the future. There is a further complication on asset retirement obligations, the cost Oxy needs to incur to permanently deactivate a well in order to conform to Environmental legislation.
The US shale business is operating cash flow dead at WTI @ $20, if WTI @ less than $10, the business is a toxic asset.
Oxy’s 3 way collar hedges expire in 2020 and is considered as an equity infusion of $1.2B. At current pricing, this can tide over 50 days of cover, of which 10 days has been extinguished. Next year, it no longer has this protection.
The mark that distinguishes the Rembau Times is that we are fact based and not based on conjecture. We spend countless hours to build a simple, intuitive financial model which we do share our work with the outside world. The link is here.
We will start with the good news first. Bottom line is that Occidental will most likely not go under because of the Revolving Credit Facility but management could be incentivised to do a voluntary Chapter 11 bankruptcy if oil prices remain where they are in 3 months time. The intrinsic value of Occidental is low to mid single digits , and that is purely due to the put option granted to equity holders by credit providers. (Equity holders can put the Company back to the debt holders if the intrinsic value falls below $0).
Profitability wise at $20 WTI, OXY assets are worth less than its liabilities as reflected in its debt pricing of 60 cents on the dollar. Near term we may see further pressure on WTI so I won’t be surprised to see Oxy trading at GE level prices for an extended period of time. WTI will need to move 250% before OXY can make an accounting profit on its US shale operations.
Good news for Oxy
- Occidental entered into a 3 way cost less collar to hedge 128.1 million barrels of oil, bench-marked to Brent. To simplify this, so long as Brent is less than $45 a barrel, OXY will receive $10. Brent is currently $21 for June and the December 20 price is $31.54. Oxy will receive $10 per barrel, we consider this a capital infusion of $1.28 billion.
2. Occidental has a $5.0b Revolving Credit Facility with no Material Adverse Clause. With Occidental’s $3.0b of unrestricted cash, this means that Occidental has $8b in liquidity.
Bad news for Oxy
- Current US Production cost is approximately $33 per Barrel of Oil equivalent, or BOE. This is not to be confused with a Barrel of Oil, because you have to weight the components that go into a single barrel, namely Crude Oil, Natural Gas Liquids and Natural Gas, with Oil being the most valuable and Natural Gas soon to be essentially worthless. All 3 components have a different price benchmark. Based on our calculations, Occidental’s current price received per BOE is approximately $11.26. So Occidental makes a loss of $22 per BOE. On its production of 1.2m BOE per day, Occidental makes an operating loss of about $25M per day. The entire capital infusion from the hedges will be wiped out in approximately 50 days at current pricing
2. Occidental has long term obligations of $68.5b, arising from its debt and purchase obligations. This figure is important because it will be a determinant in the future whether Occidental can remain a going concern when the auditors prepare their annual audit opinion. At current WTI prices, the Company auditors may need some convincing
3. Occidental’s debt is currently rated as junk, meaning Occidental cannot hope to tap the debt markets next year to refinance its debt. Occidental’s 3.400% maturing 2026 is currently trading at 58 cents on the dollar. This means fixed income investors expect to lose 42 cents on the dollar. Remember, equity investors will lose everything before fixed income investors lose one penny.
3. Warren Buffet has a $10b Perpetual Cumulative Preferred Shares yielding 8.00% cash or 8.80% if settled in shares. Assuming it’s cash settled, this will cost $800m per year, and taken together with the $1,500m Occidental pays in interest means that the cost of capital is $2,300m per year currently on a cash basis.
The future cost of capital is not worth calculating because Occidental’s debt implies an unrealistic cost of debt financing – it just states that the debt market is closed to Oxy and the only financing available to Oxy in the future will be equity financing, after it draws on its revolver.
Electing to pay Buffet in stock is not wise given the potential significant dilution it poses. Occidental’s management should just default on the preferred, stop paying Buffett and ask him to accrue the dividend on the preferred stock while doing a debt to equity deal with the bondholders . Let Buffet take the loss for doing a deal on a Sunday morning. Unfortunately, common equity goes to ZERO but the employees and the banksters get saved.
- Occidental’s dividend cut to 0 is a foregone conclusion. Those looking at Oxy’s dividend yield of 23% on Google Finance should not rely on Google Finance in making financial decisions.
2. Occidental’s is quite dependent on whether they can complete the sale of their African assets in Ghana and Algeria. It is in Total’s best interest to delay this, given the collapse of the oil market. Ghana is claiming a $500M tax charge and Algeria’s Sonatrach Group is opposing the sale of the Algerian assets. (Hint, hint: Malaysian should be able to add 2 + 2 on this one. The first 2 is that Total probably hates the price it agreed upon with Oxy. The second 2 is that Algeria is blocking the deal. Figure it out!)
3. Occidental’s cash balance as of 31 Dec 2019 was $3.5b, comprising of $3.0b in unrestricted cash and $0.5b in restricted cash.
4. Given Occidental’s short term liquidity of $8B, Occidental could ride out this oil crisis at the expense of the banks which gave them the financing offer of a life-time. Congratulations, Brian Moynihan of Bank of America.
The question is whether Occidental will want to take down the banks by fully drawing on its revolver?
Of course, doing so will mean that Occidental will get no mercy next year when it comes time to settle their debts.
Some wise investment banker may suggest that Occidental do a pre-packaged bankruptcy somewhere in the 3rd quarter, if oil prices remain where they are. Bottom line, an investment in Occidental means assuming that Occidental fully draws on its revolver and burns all bridges with their Wall Street bankers.
It will perhaps come down to the Audit Opinion at the end of the year whether Occidental could remain as a going concern. So Occidental still has at least 9 months left to fight, unless some wise banker does the prepackaged bankruptcy route.
By the way, the management of Occidental deserve an F for destroying $44B of shareholder value . (One could argue that $20B was oil market and that $24B was their own making)
Note: Bottom line, what we are really trying to communicate is that we prefer cheese 🧀 and ketchup to oil.
(Note to the VIP elderly readers: Revolver: Its like an overdraft facility for corporates. Banks offer companies revolving lines of credit in return for the fees they generate but never really expect that all the companies will draw on their revolver at the same time, like what is currently taking place. )