Morgan Stanley OXY Update

Few snips from a report dated May 18, 2022:

This week, we hosted investor meetings with OXY’s management team in New York & Boston. OXY’s strong FCF is driving rapid balance sheet improvement, supporting a commencement of share repurchases in the near-term. Longer-term, the company’s differentiated low-carbon strategy is a source of upside.

-Near-term debt goal nearly reached, buybacks on the horizon. Year-to-date, OXY has addressed $3.6 B of its $5 B near-term debt reduction goal, bringing gross debt to ~$24.9 B. On Monday, the company announced a cash tender offer for an incremental $2 B. Once this is complete, OXY will be in a position to begin executing its $3 B share repurchase program, which could all be done in 2022. With excess cash beyond the planned buybacks, OXY plans to further reduce gross debt to $18-19B, a level which should support regaining investment grade (IG) credit ratings. Once this balance sheet goal is reached, the company will shift from proactively reducing debt to addressing maturities as they come due, and excess cash will be allocated to additional shareholder returns (i.e. more share buybacks and growing the base dividend). Longer-term, management plans to grow the base dividend to a more competitive yield and set the payout at a level that can be fully covered at $40/bbl.

-Preferred equity could be redeemed with FCF as shareholder returns rise, but refinancing with new debt is unlikely. Notably, OXY’s preferred stock (owned by Berkshire Hathaway) was topical in the investor meetings. Under the company’s 2019 agreement with Berkshire, if OXY’s trailing 12-month distribution exceeds $4/sh, OXY will be required to repurchase Berkshire’s preferred shares at an amount equal to 50% of the excess distribution (e.g. 50% of the amount above $4/sh) plus a 10% early redemption fee. Management indicated the $4/sh distribution level is not a ceiling and it could begin exceeding this threshold and redeeming the preferred stock after achieving its $18-19B gross debt goal. Any redemption of the preferred would likely be done with organic FCF rather than issuing new debt as a source of funds.

-Low-carbon strategy is a potential source of long-term value creation. OXY has decades of experience handling and sequestering CO2 as part of its enhanced oil recovery (EOR) business, making commercial carbon capture synergistic with its existing operations. As an early mover in the US Energy sector in establishing a low carbon growth strategy, the company is developing multiple potentially transformative solutions to de-carbonize its own operations and provide carbon management services to other industries through its Low Carbon Ventures (LCV) business unit formed in 2018. While we do not yet reflect value for LCV in our price target, we believe it could create meaningful incremental value over time with successful execution (see Capturing the Low Carbon Opportunity). Management expects the low carbon business to generate cash flow comparable to the chemicals business within 10-15 years.

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-Near-term debt goal nearly reached, buybacks on the horizon…
-Preferred equity could be redeemed with FCF as shareholder returns rise, but refinancing with new debt is unlikely…
-Low-carbon strategy is a potential source of long-term value creation…

I buy the first two (we now generate enough cash to pay off debt and do other good things)
much more than I believe the third one (management’s story for a green future is wonderful).

The first two are pretty solid views, the third is a PR positioning statement.
As with all PR statements, some turn out to be valid, some others less so.
It’s not immediately evident to me why Oxy would be better positioned for a “low carbon growth strategy” than would any other firm with free cash flow available for deployment.
CO2 injection isn’t that.

Still, it’s a nice text clip, thanks for posting it.
Excerpting some keywords:
"debt goal nearly reached…excess cash beyond the planned…investment grade credit ratings…
excess cash…refinancing with new debt is unlikely…would likely be done with organic FCF."

It seems they are developing a theme.
They are throwing off a whole lot of cash from operations at the moment, and for the foreseeable future.
All kinds of good things are likely to flow from that.

Jim

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The good news: Ole dealraker has been buying OXY steadily for 8 months.

The bad news: I have so little of it that it makes basically no difference to my financial life.

LOL!

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"It’s not immediately evident to me why Oxy would be better positioned for a “low carbon growth strategy” than would any other firm with free cash flow available for deployment.

  1. OXY claim their existing infrastructure is one advantage (and a big one):

20,000 connected (oil producing) wells
6,000 (CO2) injection wells
2,500 miles of dedicated CO2 pipeline
20 Million tons of CO2 storage capacity
14 CO2 Recovery Plants

https://www.oxy.com/operations/performance-production/eor/

Wonder what it would cost for a new entrant “with free cashflow available” to replicate even a small version of what OXY has already built and paid for? Imagine the time and cost required to permit and build the above in today’s NIMBY environment.

  1. OXY have been in the CO2 sequestration (EOR) business for decades. Perhaps they have some technical and operational expertise that a new entrant might not have.

  2. Currently, the cost of naturally sourced CO2 is a significant (high teens?) percentage of their EOR operating expense. Reducing their CO2 input cost to zero, or even get paid to dispose of other’s CO2 emissions would be a game changer. Their “break even” oil price would be lowered, which in turn would increase their field lives and expected ultimate recoverable reserves.

  3. OXY claim their “net zero (carbon)” oil (produced from fields where CO2 sequestration took place) would command a significant premium to WTI. A type of carbon credit. “Green oil” (gasp!) if you will.

But who knows? Maybe it’s a all a pipe dream? In any case will be fun to watch.

Meanwhile this morning in Davos:

Davos updates | Greater incentives needed for carbon capture
4:32 AM ET, 05/23/2022 - Associated Press

DAVOS, Switzerland (AP) — Governments need to “make it worth the while for private industry” to invest large sums into carbon dioxide removal technologies, a top US Government advisor on clean energy and climate change policy said.

“(Governments) can do this through tax incentives…you can do this through public procurement. There’s a range of ways to make it worth private industries while,” said Varun Sivaram, the senior director for clean energy and innovation for the US department of state.

The most recent report by the United Nation’s Intergovernmental Panel on Climate Change estimates that the deployment of carbon capture removal technologies is far behind what’s needed to meet internationally set warming targets.

“We need a scale up of a factor of 1 million to get to where we need to go. And that means that by 2050, this (carbon dioxide removal technology) needs to be the size of the oil and gas industry,” said Christian Mumenthaler, the group chief executive officer of insurance group Swiss Re.

Nili Gilbert, the vice chair of carbon removal investment company Carbon Direct, said “the enormous scale of the opportunity…captures the imagination of finance” and encouraged significant participation from the financial industry.

The head of the International Energy Agency is urging countries and investors not to use Russia’s invasion of Ukraine as a reason to increase fossil fuel investments.

Speaking on an energy panel Monday at the World Economic Forum in Davos, Switzerland, Fatih Birol said the immediate response to energy shocks from the war should be an increase of oil and gas on the market. But that did not mean large and sustained investments in fossil fuels.

Instead, he says efficiencies, such as reducing leaked methane and even lowering thermostats by a few degrees this winter in Europe, would help ensure adequate energy supply.

Russia is a major supplier of oil and natural gas, with the invasion sending European countries scrambling to reduce their reliance on Moscow.

Occidental Petroleum CEO Vicki Hollub countered that oil and gas industries had a central role to play in the transition to renewable energy. She says the focus should be on making fossil fuels cleaner by reducing emissions.

Hollub says Occidental had invested heavily in wind and solar energy and planned to build the world’s largest direct air capture facility in the Permian Basin, spanning parts of Texas and New Mexico. Direct air capture is a process that pulls carbon dioxide out of the air and sequesters it.

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"It’s not immediately evident to me why Oxy would be better positioned for a “low carbon growth strategy” than would any other firm with free cash flow available for deployment.

BreckHutHigh makes a good argument against a new company entering the O&G industry being successful in CO2 capture versus OXY.

But his argument seems to exclude all the other existing O&G companies who also have free cash flow available. Does Oxy have any real advantages over them?

It seems to me their CO2 claims largely apply only to their existing operations and Permian Basin location. And they’re basically only capturing part of the CO2 purchased in the past by continuing to recycle it, and maybe sell some to others in their same local geography. I don’t see that making a major contribution to CO2 generated from combustion of fossil fuels. And direct capture from air is the highest cost process for general CO2 capture because of it’s very low concentrations.

The integrated major oil companies have as much or more experience at capturing CO2 in upstream operations as OXY. And they also have downstream operations located in major industrial complexes - which constantly generate CO2 emissions. Those huge complexes would seem to offer better opportunities to capture NEW CO2 emissions that the Permian Basin. Plus, since many of these are located on tide water, they are also convenient to CO2 storage in offshore reservoirs.

I admire OXY’s sales pitch on CO2 capture. They’re doing a great job of promoting what they have to offer. But I don’t see them having any competitive advantages over other players in the O&G industry.

Continuing, I totally agree with the comments at Davos that not enough attention and incentives is being paid to CCS. Fossil fuels offer high energy density with transportation and distribution facilities already in place. Many of their end uses cannot be supplied by electricity. Why not make them climate friendly by greater efforts to prevent (methane) and capture (CO2) their emissions. This would help avoid some of the huge new material supplies and construction needed for an all electric world. Not to mention the environmental impacts and the long timetables needed to provide these materials.

Just makes sense. Wind and Solar alone can’t accomplish what is needed to reduce climate change - particularly in the time available. Work more to improve what already exists.

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"BreckHutHigh makes a good argument against a new company entering the O&G industry being successful in CO2 capture versus OXY. But his argument seems to exclude all the other existing O&G companies who also have free cash flow available. Does Oxy have any real advantages over them?

Thanks Tex, Once again great points. Perhaps OXY does not have an advantage when compared to other E&P companies. Wish I could do a side by side comparison of all their attributes, but can’t find enough data to make a meaningful comparison.

You mentioned other E&Ps being advantaged by having downstream assets closer to “major industrial complexes”.

Possibly, but OXY just signed an LOI with EPD to potentially service the greater Houston/Beaumont/Port Arthur industrial corridors:

"HOUSTON–(BUSINESS WIRE)–Enterprise Products Operating LLC (“Enterprise”), a subsidiary of Enterprise Products Partners L.P. (NYSE: EPD), and Oxy Low Carbon Ventures, LLC (“OLCV”), a subsidiary of Occidental (NYSE: OXY), today announced they have executed a letter of intent to work toward a potential carbon dioxide (“CO2”) transportation and sequestration solution for the Texas Gulf Coast. The joint project would initially be focused on providing services to emitters in the industrial corridors from the greater Houston to Beaumont/Port Arthur areas."

https://www.businesswire.com/news/home/20220425005930/en/Ent…

Again back to your point, OXY will likely have competition:

Chevron joins Bayou Bend CCS project for first offshore carbon capture hub in US Gulf:
https://www.spglobal.com/commodityinsights/en/market-insight…

Morgan Stanley note indicated OXY management expects the low carbon business to “generate cash flow comparable to the chemicals business within 10-15 years.”

That’s a ways off.

I guess we’ll have to wait and see how it plays out.

Thanks again for chiming in.

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Thanks BreckHutHigh. Good point about Oxy marketing to the Port Arthur area potential carbon capture hub. Wonder what competition they’ll have. Hope it goes forward.

ExxonMobil is pushing a $100 billion hub proposal for the Houston Ship Channel and is also involved in two projects in Europe and, I believe, one in Scotland.

ExxonMobil is now going forward with a sizeable project in their Baytown olefins plant involving “blue” hydrogen generation for fuel together with carbon capture and storage. I’m guessing it to be economic from some incentives as well as an important industrial scale demonstration. They claim potential 30% reductions in Baytown CO2 emissions at a rate up to 10 million metric tons (mmt/yr) per year. That would represent 20% of the proposed 50 mmt/yr 2030 target for the Ship Channel project and 10% of the 100 mmt/yr target for 2050.

If XOM, OXY, CVX, and others are successful in their projects, perhaps greater enthusiasm will happen for CCS.

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Good discussions on the CO2. I thought I might chime in that on occasion I was involved with finding CO2 when we were actually looking for natural gas. The only time and place in my career when the CO2 was of any use, was when it could be shipped off to an EOR project in West Texas, and Oxy was indeed one of the buyers. Does their past experience give them an advantage? Doubtful, moving and storing gas is not rocket science, lots of companies do that. The one place it might be of use would be if some massive government subsidized contracts were to become available, and company expertise was a major criteria in awarding them. No guarantees for either of those occurring, but it makes a good PR story and is not entirely unlikely.

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“OXY plans to further reduce gross debt to $18-19B, a level which should support regaining investment grade (IG) credit ratings.”

Fitch Revises OXY’s Outlook to Positive on Accelerated Debt Reduction; Affirms ‘BB+’ Rating

https://www.fitchratings.com/research/corporate-finance/fitc…

Of Note: "Carbon Reduction Initiatives: OXY’s commitment to scope 3 emissions stands out versus U.S. E&P peers, and includes a medium-term (2032) and long-term (2050) component. To this end, OXY is further commercializing its existing Enhanced Oil Recovery (EOR) business to create a carbon capture, utilization and storage (CCUS) platform using its geologic formations. OXY is constructing the world’s largest direct air capture plant of up to 1 million metric tons of CO2 annually, with commercial operation expected in late 2024.

Management views low carbon ventures as a growth engine that could eventually rival chemicals in earnings; however, a number of regulatory uncertainties still surround the business given its early stage development, including section 45Q tax credits. Fitch anticipates the company will maximize the use of third-party capital and credits in funding the growth of this platform."

Just saying…