Occidental Petroleum Corp (OXY) — Q1 2021 Earnings Call Transcript

Thank you, Chuck. Good afternoon, everyone, and thank you for participating in Occidental's First Quarter 2021 Conference Call. On the call with us today are Vicki Hollub, President and Chief Executive Officer; and Rob Peterson, Senior Vice President and Chief Financial Officer. This morning, we will refer to slides available on the Investors section of our website. The presentation includes a cautionary statement on Slide 2 regarding forward-looking statements that will be made on the call this morning. I'll now turn the call over to Vicki. Vicki, please go ahead.

Thank you, Jeff, and good afternoon, everyone. I'd like to start this morning by saying how pleased we are with our first quarter operational and financial performance. The momentum generated by our improved cost structure and capital intensity leadership was a catalyst for our strong results this quarter and is expected to continue to provide a solid foundation for free cash flow generation. This morning, I will cover our first quarter operational performance and divestiture progress. Rob will cover our financial results and balance sheet improvement as well as our updated guidance, which includes an increase in guidance for midstream and OxyChem's 2021 earnings. Our first quarter results are a perfect example of how our ability to consistently deliver strong operational performance has strengthened our financial position. In the first quarter, we generated $1.6 billion of free cash flow, which is our highest level of quarterly free cash flow in a decade. We also closed almost $500 million of divestitures, repaid $174 million of debt and exited the quarter with approximately $2.3 billion of unrestricted cash. Our plan to stabilize 2021 production at our fourth quarter 2020 exit rate is on track. We delivered first quarter production from continuing operations of over 1.1 million BOE per day, with total company-wide capital spending of only $579 million. We're particularly proud of this achievement, given the operational challenge posed by winter storm Uri. Our domestic oil and gas operating cost of $7.20 per BOE continued to demonstrate the lasting impact of our cost-reduction measures and includes about $83 million of atypical costs related to the winter storm. I want to note that we have fully recovered from the storm with no lasting impact. Even with incurring storm-related costs in the first quarter, our full year domestic operating guidance has only increased by $0.10 per BOE, which represents a significantly smaller increase than the approximate $0.25 per BOE that the $83 million in total OpEx would have otherwise added. This is a significant achievement made possible by our teams continuously seeking efficiencies and finding innovative ways to safely and effectively lower costs. In the first quarter, OxyChem benefited from robust PVC pricing and gradual strengthening in the caustic soda market. OxyChem's integration across multiple chlorine derivatives provides us with the ability to optimize our caustic soda production while opportunistically adjusting our production mix to maximize margins. OxyChem's ability to adjust to rapidly changing market dynamics was invaluable during the downturn last year, and we were able to provide critical products to the medical, pharmaceutical and disinfection markets to respond to COVID. Given the recent improvements in the chlorovinyl and caustic soda markets, we expect OxyChem to extend its track record as a market leader and consistent generator of free cash flow. Additionally, during winter storm Uri, our team was able to safely protect our assets as well as provide essential products to our customers. Our team's effective response limited the storm's impact on facility maintenance costs to an immaterial amount. Midstream and marketing's outperformance compared to guidance in the first quarter was primarily driven by our ability to optimize long-haul gas transportation in the Rockies, along with the timing impact of export sales. Following the increase in activity in the fourth quarter, our oil and gas business continued to push the envelope with new efficiency gains as we seamlessly transitioned into the first quarter. Our Permian teams outperformed expectations in the first quarter by setting new drilling records in New Mexico, the Texas Delaware and the Midland Basin, while also driving down costs. Our first quarter Permian achievements are especially impressive as we have now augmented the efficiencies of our Oxy Drilling Dynamics with remote directional drilling, an exciting innovation that allows the drill bit to be steered from a separate location. Being able to control and optimize our operations remotely and instantaneously apply shared expertise to similar activities has numerous advantages that we expect our operations to benefit from in the future. We also continue to achieve significant efficiency improvements in the Rockies, where in the first quarter, our DJ drilling team reached our lowest average cost per foot in program history. I'd also like to highlight Oman for their best-ever HES performance with no recordables in the first quarter while drilling the longest laterals in Oxy Oman history and achieving record drilling times. After a pause of the issuance of new drilling permits on federal land earlier this year, we have now started to see the process move forward again with the approval of new permits. We currently do not expect the permitting process to have an impact on our activity levels as we still plan to run an average of 11 rigs in the Permian this year and 2 in the Rockies. In late April, I testified before the U.S. Senate Energy and Natural Resources Committee in support of lifting the federal leasing moratorium. As I told the committee, continued onshore oil and gas development means high-paying jobs, community reinvestment and meeting energy and product needs during the transition to a low-carbon economy. We look forward to working with Congress and the administration on ways to create clarity and short- and long-term regulatory certainty.

Thank you, Vicki. I want to echo Vicki's comments on our strong performance in the first quarter. Our cash flow priorities illustrate the importance we continue to place on capital discipline, free cash flow generation and balance sheet improvement. As we look ahead on the steps necessary to transition from our current to our medium-term cash flow priorities, our focus on balance sheet improvement will continue to influence our financial policies. Throughout 2020, which was one of the worst years our industry has endured, we focused on deleveraging and have continued to reduce debt in the first quarter of this year. We repaid approximately $9.6 billion of principal since August of 2019, with more to come as we can complete our divestiture program combined with leveraging our ability to rate excess free cash flow and maintain our commitment to capital discipline. On past calls, I've highlighted our preference for a viable path to return to investment-grade credit rating. We're allocating excess cash flow to our medium-term priorities. Our credit ratings are based on several factors, including a certain level of debt, returning to investment-grade in a mid-cycle commodity price environment may include reducing debt to the mid-$20 billion range. We are not there here today, but we believe this goal is achievable, given our potential to generate free cash flow. We repaid $174 million of debt in the first quarter and now have less than $225 million of maturities due the remainder of 2021. If we generate cash from organic free cash flow, close our remaining divestitures, we have some more options available to deploy that cash, improve our balance sheet. We have the option to call the 2022 floating rate notes prior to maturity and may at times allow our cash cushion to build until maturities come due. We have additional options available to address future maturities, which we are currently evaluating. We may also consider retiring $750 million of notional interest rate swaps later this year for the fair value amount, which was approximately $665 million at quarter end. This would improve cash flows by almost $50 million per annum at the current curve. In the first quarter, we announced an adjusted loss of $0.15 per share and a reported loss of $0.36 per share. The difference between our adjusted and reported results is primarily due to a gain on asset sales and positive fair value adjustments, offset by planned lease expiries and a legal contingency related to our 2016 settlement with Ecuador. This quarter, we classified all derivative instruments with mark-to-market adjustments as items affecting the clearability. We expect this change will be helpful to investors comparing underlying business performance between periods and reconciling actual results to our guidance, which had previously excluded the mark-to-market adjustment.

Thank you, Rob. We are encouraged by the positive reception our 2020 Climate Report received following its release in December as well as the enthusiasm our low carbon strategy continues to generate. We understand that many of our stakeholders have a desire to learn more about our low carbon projects and the returns these projects will generate. While we are not yet able to share the economics, we will have created partnerships to finance and deploy cutting-edge CCUS technology, which leverages our expertise and our tens of billions of dollars worth of CO2 infrastructure, assets and floor space. We are creating these cross-industry opportunities for others to invest alongside us to maximize the deployment pace and carbon removal impact. We look forward to sharing more information when possible. As part of being a socially and environmentally responsible operator, we consistently make operational improvements in addition to working toward our net 0 goals. In the first quarter, we started a water recycling facility in the Midland Basin and began utilizing recycled water in our South Curtis Ranch development. In partnership with an industry-leading water midstream company, we were able to increase our water recycling efforts and lower cost. Recycling water has been a large focus of ours in New Mexico for several years, and we are pleased to have been able to expand this effort into Texas. Before we begin the Q&A, I want to announce that in April, we became the first U.S. oil and gas company to commit to adopting the World Economic Forum's stakeholder capitalism metrics. This commitment will guide our process to incorporate the forum's metrics most relevant to our business into our environmental, social and governance reporting. We believe this is the appropriate framework to supplement our reporting on ESG progress, enhance transparency and strengthen our engagement with investors and other stakeholders. We'll now open the call for your questions.

I would like to ask about direct air capture, but first, could you provide an update on your dividend breakeven? Last time it was mentioned to be in the high 30s. I assume it is lower now due to the improvements seen in chemicals and midstream. Additionally, could you comment on your free cash flow generation this year at the strip, adjusted for working capital? I believe there are many questions on this topic today, especially considering the current performance of the stock.

Sure, Dan, thanks. So our revised guidance, when you combine in operational achievements, did lower our breakeven, I would say, mid-$30 range on a WTI basis before the preferred dividend. Specifically, we give a range because it is influenced by a number of factors that you listed, including the cash flows, including the natural gas prices, realization for our products, divestiture timing and where chemicals and midstream falls in respect of earnings guidance. And obviously, this quarter, we were able to significantly improve our guidance on both the chemicals and midstream business, which has a material impact on that range. In addition to that, as we take that organic cash flow and we can further improve the breakeven and doing things like I mentioned in my opening comments regarding interest rate swaps, where we retired the $665 million of notional value or $750 million notional value, that was $665 million at the end of the quarter, we're able to eliminate about $50 million of interest costs for the year using the current curve. So there's a lot of things that go into that.

Okay. I'm sure you're going to get more on that. So Vicki, I wanted to go back to the direct air capture. I came across a document, it was a presentation that someone on your team made to the California Air Resource Board, I think, back in October that talked about building or at least having 4 facilities online in 2025. And there was also a petition to get credits or, I guess, generate the credits during the construction phase. So can you just talk about that, and what that might be able to do in terms of your ability to finance this in creative ways as you just touched upon?

Yes, we have no concerns about financing our first direct air capture facility. Once both trains are built, we will be able to capture 1 million tons of CO2 per year. We aim to generate some cash while building the facility, which is what the request was about. If we could secure that funding, it would allow us to accelerate the development of the next facility. We believe this aligns with the goals of CARB and others, to have a positive environmental impact while also creating shareholder value. We are exploring multiple ways to speed up our direct air capture efforts in the Permian. Additionally, we are considering the potential benefits of modifications to the 45Q tax credit, as transforming it into a direct pay model for captured carbon could further enable quicker construction and implementation of our technology.

Vicki, I know you mentioned in your prepared remarks that you were fine with the permits, and that they won't influence the two rigs in the Rockies. I'm just curious, when the decisions come out in August, what changes we might expect in either the Gulf of Mexico or the Rockies, depending on the outcome.

I think the changes that will come out will not impact current leases. I do believe that we'll be able to continue permitting on current leases. My concern is that there could be a moratorium, a longer-term moratorium on picking up additional leases. That would be bad for our industry. It would be bad for the United States. It would put our country in a position where we would likely have an even tougher time increasing production above where the United States is today. As you know, we were at one point over 13 million barrels a day of oil production from the U.S. That's a scenario that gave us strength in world politics. It gave us the ability to completely supply our own oil and products domestically. We would not have to import very much at all at a 13 million barrel a day level because I believe our refining capacity is somewhere near 17 million. So we would have some capability to be almost completely independent. With a moratorium on federal leases, that would really drive down our industry's ability to react. Now where we are in that, we've got 9.5 million acres of land to develop in the U.S. And of that 9.5 million acres, I think only about 1.6 million are federal, and about half of that is offshore. So from a new lease standpoint, there are some companies that are in better positions than others, and we believe we are. But what I'm advocating for is the industry and for the country because the other thing about this is some of this is being touted as a way to reduce emissions for the United States, which would be definitely a bad move because we are very prudent with what we're doing in the United States compared to a lot of countries around the world. We've reduced emissions significantly in the U.S. and continue to push technologies to further reduce. API, we're part of API, and a lot of companies within API have committed to a voluntary partnership where we're all working to share technologies and to help each other reduce emissions and to get the best available technology in place to address emissions and climate change. So I think that, for me, the biggest worry is not on existing leases. It's just that the moratorium could be extended for a long time on picking or anybody picking up any new leases.

No, I really appreciated the details. I have a follow-up question. I'm curious about your financial investments, specifically what types of financial investments you are considering in carbon capture, as well as in other clean energy initiatives. It seems like you have an advantage, particularly in the Perm area compared to others. My main question is whether the funds you allocate for these investments will affect your spending on upstream activities, or if they are relatively independent.

No. Our low carbon strategy is closely linked to our CO2 enhanced oil recovery projects. We initiated this strategy to secure a more sustainable and cost-effective source of CO2 for our enhanced oil recovery. Currently, we find ourselves in an exciting position in the Permian Basin, where we have a significant presence in reservoirs, infrastructure, and resources, including processing plants and pipelines, all essential for advancing the development of an additional 2 billion barrels in our conventional reservoirs. We haven't calculated the potential from CO2-enhanced oil recovery in the shale yet, but applying this method in the Permian, DJ Basin, and Powder River positions us to generate new reserves and production from existing reservoirs for decades to come. This strategy aligns with our goal of creating value for our shareholders by enabling extended production of more reserves than typically possible from conventional or unconventional resources. In conventional reservoirs, CO2 flooding can achieve recovery rates of up to 70% or even better, while primary methods usually yield only 20% to 25%. In unconventional plays, where typical recovery ranges from 10% to 12%, our trials indicate that CO2-enhanced oil recovery could allow for 75% additional recovery, or perhaps even double that. We are in a favorable position for substantial future development within our operational areas that already have the necessary infrastructure. Moving forward, our incremental production and recoveries will continue to decrease in cost, particularly as we establish direct air capture facilities. Furthermore, executing our NET Power technology will also help lower costs. NET Power generates electricity more affordably by combusting hydrocarbons with oxygen, resulting in a pure CO2 stream with no other emissions, which we can utilize in our reservoirs. This means we have multiple avenues for enhanced oil extraction at lower costs. Consequently, our overall cost structure will keep declining, not just from debt reduction but also from advancements in field operations and development. Additionally, we aim to supply the aviation and maritime sectors with net carbon zero oil, making us a key player in those industries. This collaboration with United for the first direct air capture facility is genuinely exciting for us. Apologies for the lengthy response. I’ll pause here for any further questions, but we are eager to share more soon. We are currently in the midst of various processes and discussions, and we anticipate providing more information by the fall or toward the year's end, along with a model for better understanding.

Rob, I hate to speak on the tax breakeven question, but I want to go over the math with you real quick. $1.6 billion of free cash, obviously, before working capital. Annualized is $6.4 billion. $215 million per dollar is $30, and the average WTI price in Q1 was $57.61. So how do you get mid-30s? Even if I add back the press, that still only gets you to low 30s. What am I missing?

So I think that part of what is missing from that is certainly the CapEx and then also where, I would say the chemicals, their performance in Q1, as you can see in the guidance, is sustained throughout the year. The midstream inclusion in Q1 is more of a one-time event associated with winter storm Uri. So I think it's part of annualizing the Q1 numbers. That's what I would modify your analysis by.

Yes. I would say that if I include the unsolicited offers we've received, we currently have offers that would exceed the $2 billion minimum target. However, in this environment, we expect to meet the $2 billion. Whether we go above that will depend on the broader economic conditions. We also need to assess the value of any divestiture against the future cash flow it would produce. This is a value proposition for us. Additionally, we must ensure we generate enough cash flow to cover our debt maturities and other costs, including interest rate swaps.

I would like to follow up on the cash flow questions from the quarter. Can you explain again why the cash flow related to working capital was so significant? How should we view the reversal? It seems like much of this is related to timing, and export barrels will eventually reach their final destination. I would assume that a considerable amount will return, but please help us understand this better.

Yes, Neil. I'm glad to explain that for you. In a typical first quarter, we usually see a significant draw, and this quarter was notably larger than in previous years. For instance, in 2018, the first quarter draw was around $700 million and in 2019, it was about $900 million. In contrast, the draw for the first quarter of 2020 was approximately $200 million due to opposite market conditions caused by the pandemic and price wars. This year's $1.3 billion draw is exceptionally high, primarily driven by changes in commodity prices and the timing difference between revenue recognition and cash received. At the end of 2020, WTI was roughly $48 per barrel, while by the end of March, it had increased to $61 per barrel. This 30% price hike has significantly impacted both our accounts receivable and inventory, particularly considering our midstream operations and the number of barrels in transit. This situation has been aggravated by the ongoing shut down in Europe since last year's third quarter, leading us to shift our export strategy towards Asia, which involves longer transport times. Furthermore, we are currently operating with a modest capital budget, resulting in minimal accounts payable or capital expenditure. Thus, when we examine the situation, it's a mix of price influences and various first-quarter factors, such as financial interest payments, property tax payments, and a substantial contribution to the APC pension plan during this period. Overall, as receivables begin to come in, we anticipate some of this will reverse throughout the year.

Is it reasonable to expect that Q2 will yield a positive cash inflow from working capital, assuming no other factors change?

Again, it depends largely on what happens to the price going into the second quarter also. But we would expect it to. Yes. So absolutely, nothing happy to do than talk about our chemical business, which had an excellent start to the year. When you look at the chemical business, it has both some impacts from winter storm Uri, to some extent, but also because of how winter storm Uri impacted the overall business itself. And so chlor-alkali production struggled significantly in March post storm. If you think about Uri, it had a much wider impact than any individual hurricane we had in the past. And so you still have a lot of inspections, et cetera, going on, restarts going in the month of March. And that has extended into after a very difficult hurricane season last year. And so going into the end of 2020, we already had a pretty tight supply-demand balance in the second half of the year. And that was coupled with a pretty significant amount of demand. As you know, building products are in very high demand right now. So our PVC demand and margins were significant already going into the year. And so if you look at our operating rates as the industry, they're only about 71.5% for the first quarter of '21, whereas last year, they were 89%. And so the combination of the stronger demand, coupled with the production off-line to start the year, has already tightened up an already tight supply-demand balance.

My first question probably maybe for Rob. I just want to make sure I heard your comments right in the prepared remarks. So getting down to the mid-$20 billion range on gross debt, that's where you think you need to be to hit IG status at mid-cycle prices. And I think ultimately, that's an important goal for you all. So about $10 billion more to go from there. Can you just remind us what your view of mid-cycle prices are at this point? And how does this jive with your prior target of 3x leverage as the trigger for growth, which I think was also at mid-cycle prices?

Yes, it's around the $50 range. If you look at the price estimates used by many rating agencies, they are currently in the high 40s, close to $50. They don’t adjust their price estimates based on the current environment of being in the mid- to high 60s, which significantly impacts the breakeven point. Is it exactly $10 billion? There are many factors to consider, as I mentioned earlier, but it's in that vicinity. Other factors could lead to it being a little higher or a little lower than that. There are numerous elements to take into account, but it’s approximately within that range.

In regard to our medium-term goals, we have several factors to consider including sustainable dividends and growth capital. Additionally, we have a target for gross debt. I'm curious about how we might balance these priorities. Reducing debt will take some time, but we also benefit from strong oil prices and upcoming asset sales. As we evaluate our free cash flow and the new debt targets, when will we be able to reconsider the focus on growth in relation to the dividend and other financial obligations?

Yes. So Jeanine, I want to emphasize that, similar to Vicki's statements, our primary focus is on reducing leverage and striving to reach an investment-grade level. This will involve utilizing proceeds from both our business's free cash flow and divestitures. By combining these efforts, we aim to lower our outstanding costs. We have various strategies in mind for how we can effectively apply this cash to reduce debt in the short term. Eventually, our discussions will shift to medium-term priorities, particularly regarding the dividend. However, we have not yet established a specific policy regarding the dividend's structure. It will need to be sustainable, as we have previously mentioned in our priorities. This may involve a mix of fixed and variable components, but we have not finalized those details yet. Our focus on these discussions will occur after we have made further advancements in reducing our debt.

I would just add to that. We had this great production profile right now. And with the production profile that we have, the chemicals business supporting it, that what we're really focused on is margin expansion. We have lots of opportunity for that, and that's what we're most excited about. So there will be continuing shareholder value growth through margin expansion.

So my first one kind of builds actually on that last point, Vicki, on margin expansion and just the comments you had in the prepared remarks as well on cost reductions. You had said that you were able to identify some cost-reduction opportunities in the quarter that offset some of the winter storm impacts. I was wondering if you could comment just whether that was deferrals or more structural reductions? And then as part of that, as we think about the margin expansion opportunities going forward, are you still identifying things like upside with contribution from the Anadarko transaction? Or maybe said another way, is there still more room to run on reducing the cost structure here? And what are some of the levers to drive that cost structure down?

Yes, you're correct. There are additional opportunities to further decrease our cost structure in both capital and operating expenses. For instance, we recently reviewed our drilling performance from 2015 to 2021. We implemented our physics and logistics program, Oxy Drilling Dynamics, in our domestic operations in 2015 and expanded it internationally in late 2016. I’ve mentioned before that in all areas where we've introduced this program, we've seen a cost reduction of about 20% to 30%. Currently, our data shows that we've reduced our drilling cost from $200 a foot in 2015 to $135 a foot in 2021, on a global scale. While we've highlighted improvements in the Permian Basin, similar enhancements have also occurred in the DJ and Powder River Basins, and now Oman is also benefiting from this proprietary process we've developed. We’ve started applying it in the Gulf of Mexico as well, with promising results that we’ll quantify and report soon. Regarding drilling, some might think we've maximized our improvements already, but I can assure you that from 2019 to 2020, we still managed a 14% improvement despite the downturn. This year, we've seen an additional 4% improvement after just one quarter as we increase rig activity, indicating our efforts are effective. On the completion side, we're breaking records for the number of fracking operations we can achieve in a 24-hour span, which is also an area of enhancement. Our Permian team is diligently working on subsurface modeling, which has become a top priority for us due to the variations in the shale play. We've strengthened our subsurface expertise over the past 6 or 7 years, with some incredible talent in-house. What we've learned about the shale play is now being applied to conventional methods and seismic evaluations, facilitated by the successful work done by the Anadarko team with 3D seismic technology. Our domestic teams have been examining best practices from others and improving upon them. In every aspect of our operations, we aim for continuous improvement, and that’s yielding ongoing benefits. Oman is employing an Oxy jetting system to enhance recovery from existing wells through a process that maximizes reservoir contact in both vertical and horizontal environments. The approach allows us to extract more from developed reservoirs, which is crucial. I'm confident we will continue to decrease costs across operating expenses, drilling, completion, and facilities. Our teams have been determined to achieve this, even during the pandemic, with significant accomplishments. In New Mexico, for example, they reduced our breakeven point by $10 a barrel in several areas through their efforts. All of this is incredibly promising as we look ahead, given our established presence in regions where we excel.

I would like to add that while the exciting aspects of the business that Vicki discussed may not seem thrilling from an outside perspective, particularly when it comes to the debt reduction strategy, we are dedicated to moving this forward so we can shift the narrative of the company to focus on its future potential. We believe that as we reduce our debt, it will increase our equity value and overall enterprise value, which benefits our shareholders. Although discussions about debt reduction may not appear particularly engaging, there are indeed exciting developments happening. Sometimes we overlook the significant progress we've made since the acquisition, consistently surpassing what we previously thought was possible.

Yes. No, that all definitely makes a lot of sense. And I think the progress forward and line of sight on the debt reduction is definitely a good story as well. And maybe then shifting focus to some of the other initiatives. I know carbon capture and low carbon, you spoke a few times already, but I have one follow-up there. As we think about the milestones from here to reaching FID on some of these potential projects, including the direct air capture project in the Permian, can you just walk us through what's remaining there? It sounds like policy and financing isn't one of the milestones at this point. But what are we looking for in order to bring that project to fruition?

The significant step was selecting our engineering and construction partner, which is Worley. The front-end engineering process is currently underway. We anticipate reaching final investment decision early next year and starting construction by the end of next year. I don't foresee any changes to our schedule unless an unexpected macro event occurs. Our major projects team, led by Ken Dillon, along with Worley, has formed a sub-team that, as the front-end engineering progresses, is already identifying ways to optimize the designs.