Occidental Petroleum Corp (OXY) — Q2 2021 Earnings Call Transcript

Thank you, Chad. Good afternoon, everyone, and thank you for participating in Occidental's Second Quarter 2021 Conference Call. On the call with us today are Vicki Hollub, President and Chief Executive Officer; and Robert Peterson, Senior Vice President and Chief Financial Officer. This afternoon, 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 afternoon. I'll now turn the call over to Vicki. Vicki, please go ahead.

Thank you, Jeff, and good afternoon, everyone. Our strong operational performance in the second quarter continued to drive robust financial results, marking our second consecutive quarter of generating the highest level of free cash flow in over a decade. Like last quarter, our cost structure and capital intensity leadership were key factors in our strong outcomes, providing a solid foundation for future free cash flow generation. We were particularly pleased to be able to launch a tender process at the end of the second quarter to retire over $3 billion of debt using excess cash from operations and proceeds from divestitures. The completion of this tender represents a significant step forward in our debt reduction efforts after making incremental progress in the first half of 2021. This morning, I'll discuss our second quarter operational performance and divestiture progress, while Rob will go over our financial results, balance sheet improvements, and our updated guidance, which includes enhancements to our DD&A rate, increased full-year production guidance, and updated earnings expectations for midstream and OxyChem in 2021. In the second quarter, all our businesses outperformed. Our capital discipline and efficiency, coupled with an improving commodity price environment, have positioned us to achieve the highest level of free cash flow since WTI hit $145 a barrel in the third quarter of 2008. We are proud of our teams for this accomplishment and appreciate their ongoing efforts to improve our capital execution and operational efficiencies, further expanding our margins. We ended the quarter with approximately $4.6 billion of unrestricted cash, excluding cash received in July from the recently closed divestiture and cash used for the debt tender that also closed in July. Rob will elaborate on that, but I want to emphasize our satisfaction with the progress we are making in reducing debt and strengthening our balance sheet. Turning to operational results, our oil and gas business delivered second quarter production from continuing operations of over 1.2 million BOE per day, with total company-wide capital spending of nearly $698 million. Our domestic oil and gas operating cost of $6 per BOE was substantially below our full-year guidance as our teams demonstrated their innovative operational expertise, finding new ways to safely reduce costs. In the second quarter, OxyChem benefited from strong PVC demand and pricing as well as a gradual recovery in the caustic soda market. We believe the fundamentals for these markets will remain strong throughout the second half of 2021, and we are confident in increasing our full-year guidance to a midpoint of $1.25 billion, nearly a 60% increase over our original expectations. The ability of our oil and gas business to navigate challenges while increasing efficiencies has been transformative. Over the past six months, we overcame significant weather challenges and divested a producing asset, enabling us to regain lost production and raise our full-year production guidance for continuing operations to 1.15 million BOE per day. We are encouraged by strong well performance across our portfolio. For instance, in the Texas Delaware, we recently launched a new Silvertip development producing about 20% more oil compared to previous developments in the area. Additionally, we started a five-well development approximately 10 miles southeast of Silvertip, achieving average 30-day peak rates of nearly 5,000 BOE per day. Operationally, our teams continue to set new efficiency records while constantly seeking improvement opportunities. We achieved new quarterly records in feet drilled and hours pumped in a single day. In the Midland Basin, we set a new drilling record with over 9,500 feet drilled in 24 hours, contributing to a new Oxy Permian spud-to-rig-release record, completing a 10,000-foot horizontal well in just eight days. In the DJ Basin, we broke the company-wide record by pumping over 23 hours in one day. Through Oxy Drilling Dynamics in the Gulf of Mexico, we've significantly decreased drilling costs and durations, with wells drilled in 2021 costing 15% less on average than in 2019. As I mentioned on last quarter's call, we've seen excellent results from leveraging remote operations. Our innovative mindset and ability to embrace technological advancements have allowed us to continue pushing performance limits, giving me confidence that our capital efficiency will remain best-in-class. Our divestiture strategy progressed in the second quarter with the closing of a non-core Permian acreage sale for around $510 million. With our industry-leading inventory depth, we value the opportunity to monetize these assets at an attractive price, given it is unlikely we would have developed this acreage soon. We anticipate completing at least $2 billion in divestitures post-Colombia. As we’ve stated previously, we prioritize delivering value for shareholders over meeting timelines. I want to briefly discuss our Chemical business and how we intend to integrate its leadership and expertise into our Low Carbon Ventures initiative. OxyChem's success is evident through its financial performance and consistent free cash flow generation. OxyChem has reliably generated free cash flow during past downturns, and as the macro environment improves, it is set to achieve record earnings this year, exceeding 2018 results. The business is likely to further strengthen in future years, particularly as caustic soda, a key profit driver, has only seen a moderate price recovery so far. Last quarter, I discussed how the integration of OxyChem across various chlorine derivatives enables us to optimize caustic soda production while adjusting our production mix to enhance margins. We have ample opportunities to apply this integration approach as we explore collaborations between OxyChem and our Low Carbon Ventures business. As a major PVC and caustic potash producer, OxyChem possesses the engineering, R&D, and process technology expertise, along with the production capacity necessary for building our Low Carbon business. OxyChem is a global leader in the customization, handling, and application of PVC, which will play a crucial role in the establishment and operation of our direct air capture facility. We are also among the largest producers of caustic potash, a vital chemical utilized in the direct air capture process for separating carbon dioxide for sequestration and carbon-neutral enhanced oil recovery. Our extensive equipment design knowledge and experience with caustic potash will be instrumental in optimizing our direct air capture facility efficiently. Besides being a market leader and a consistent free cash flow generator, OxyChem is essential for our current and future business endeavors. It is noteworthy that OxyChem excels in health, safety, and environmental performance, having recently earned 31 Responsible Care awards from the American Chemistry Council, representing the leading performance accolades in the U.S. chemical manufacturing industry. These awards recognize OxyChem's achievements in safety, waste reduction, and enhanced energy efficiency. Many of the awarded initiatives focus on waste minimization, reuse, recycling, and energy efficiency, all contributing to our 2025 sustainability goals. I will now pass the call to Rob, who will detail our financial results for the second quarter and provide guidance for the rest of the year.

Thank you, Vicki. Our businesses continued to perform well in the second quarter as our free cash flow generation affirmed our confidence in Oxy's ability to generate cash in a healthy price environment. The strong performance contributed to a quarter end unrestricted cash balance of $4.6 billion. On our last call, I mentioned the potential for a partial reversal of the working capital change incurred in the first quarter. As expected, we benefited from a positive working capital change this quarter of approximately $600 million, further contributing to our cash build during the quarter. As Vicki mentioned, we launched a tender late in the quarter, which enabled us to repay over $3 billion of debt in July. Subsequent to successful execution of a debt tender in July, we received proceeds from the non-strategic Permian acreage, partially refreshing our post-tender cash position early in the quarter. In the second quarter, we announced an adjusted profit of $0.32 and a reported loss of $0.10 per diluted share. While we placed greater importance on cash flow generation, especially as we are focused on deleveraging, we are pleased to be generating income on an adjusted basis. Indeed, this is a positive indication that our financial position continues to improve. Our reported results were less than our adjusted results primarily due to the mark-to-market impact of derivatives. We delivered outstanding production results year-to-date while having deployed less than half of our full year capital budget of $2.9 billion. We expect capital expenditure to remain within budget, demonstrating our commitment to capital discipline and our capital intensity leadership, even as capital spending has been higher in the second half than the first half of the year. The positive working capital change realized in the quarter was driven by lower cash payments for items that are accrued throughout the year and lower crude inventory from fewer barrels in the water, partially offset by a higher accounts receivable balance due to the increase in commodity prices. As the interest payments on our bonds are made semiannually, our cash interest payments are going to be lower in the second and fourth quarters than they are in the first and third quarters. During the downturn last year, we received approximately $1 billion of additional cash flow from our oil hedges. To obtain a costless structure, we sold a 2021 call position of 350,000 barrels a day with an average strike price of $74.16 Brent. As the commodity prices rose at the end of the second quarter, we made payments of $5.7 million under the sold call position and $1 million under our gas hedges in July. Cash settlements paid to date on the hedges have been minimal and are certainly worth the benefit we received last year. We continue to maintain an opportunistic approach towards hedging, and the forward curve is supportive but have not added any hedges past the end of this year. We believe creating a manageable debt maturity profile and reducing debt is a more effective long-term solution to de-risking the balance sheet while providing shareholders with exposure to commodity price gains. We raised our full year production guidance following our strong second quarter results and have increased our earnings guidance for OxyChem and midstream for the second time this year, reflecting strong first half performance and improved market conditions. We expect that 2021 will be a record year for OxyChem, even surpassing our earnings in 2018. We benefit from exceptionally strong caustic soda prices in the middle part of that year. Midstream is expected to benefit in the second half of the year from continued higher sulfur prices at Al Hosn as well as an uplift in the third quarter related to the timing of export sales. We also lowered our DD&A guidance for 2021, reflecting the midyear reserves update. This update takes into account more supportive trailing 12-month commodity prices at midyear compared to year-end 2020 as well as our activity plans and recent success in lowering operating costs. The combination of these factors has increased our proved reserves, which we expect to result in a lower DD&A rate going forward. Our production in the second half of 2021 is expected to average 1.14 million BOE per day. Production in the second quarter benefited from time-to-market acceleration in the Rockies and Permian. Favorable weather conditions and optimization of planned maintenance schedules to better sequence shutdown activities resulted in lower-than-expected downtime in the Gulf of Mexico, contributing to higher-than-expected production. Our expected third quarter production of 1.145 million BOE per day includes an allowance for seasonal weather and maintenance in the Gulf of Mexico, the divestiture of approximately 10,000 BOE per day in the Permian, and the timing impact of our Rockies capital program, which was front-loaded in 2021 as well as PSC impact due to price. Even as production in the second half of the year is expected to be lower than the impressive second quarter production results, we remain confident in our production trajectory leveling out as we enter 2022, where we anticipate a production pattern similar to 2021. We have updated our activity slide to include two additional New Mexico rigs. The New Mexico activity change will be fully funded through the cost savings and optimization of our capital projects gained through efficiency improvements and will not increase our capital budget. Adding activity in one of our highest return assets will place us in a strong position as we transition into 2022. With the successful completion of our debt tender, we paid over $3 billion of 2022 through 2026 maturities and have a clear runway over the next few years. As we generate cash from organic free cash flow, we continue to value the options available for additional debt reduction, and we'll seek to further our debt maturity profile so that we're not exposed to any significant amount of maturities in any single year. The options available to us for debt reduction include potentially calling the 2022 floating rate notes prior to maturity, executing additional tenders, exercising attractive make-whole provisions, pursuing all the market debt repurchases, or we may choose, in some cases, to build a cash position which may be applied towards retiring maturities as they come due. We also plan to retire $750 million of notional interest rate swaps in the third quarter for the fair value amount, which will improve cash flow by almost $50 million per annum at the current curve. We entered the second half of 2021 in a strong position at the beginning of the year, and as we look forward, we remain focused on maintaining a strong liquidity position, deleveraging to regain investment-grade metrics and preserving financial policies and cash flow priorities and embedding capital discipline. I will now turn the call back over to Vicki.

Thank you, Rob. We are proud of the substantial progress in delivering our near-term cash flow priorities. We have significantly derisked our balance sheet with the successful completion of our recent debt tender. And this marks the next stage of our deleveraging effort as we work to further reduce debt and to lower our breakeven. While we still have work to do before transitioning to the next stage of our cash flow priorities, including returning additional capital to shareholders, we're confident that the steps we have completed to date and the strong operational performance that we continue to deliver will accelerate our progress. We'll now open the call to your questions.

And really strong results here on Chemicals, and that's where I want to start. Can you talk to your views on caustic soda and PVC pricing for the remainder of the year and next year and the sustainability of the margins that we see out there?

Yes, Neil. We continue to see very strong conditions in both our vinyl business and steady improvements in the caustic soda business, as Vicki indicated. As you can see on Slide 7 of the deck, these two businesses are the major profit drivers for our Chemical business. And it's unusual, but we do have conditions when both businesses are seeing favorable market conditions, the earnings impact that you're seeing is significant. So on the PVC business, the business remains extremely strong due to a tight supply/demand balance. On a year-to-date basis, we're seeing domestic demand as an industry about 16% higher compared to the same period in 2020. But more importantly, it's up 13% from where it was in 2019 in a non-COVID period. Strong demand is also attributed to really low levels of inventory and supply chain, combined with the construction sector, which we're seeing in a lot of their construction materials. We expect demand to remain strong with a very favorable housing start outlook, mortgage rates remaining low, which tends to also drive historically the business and a lot of investment remodeling. Those factors are all pointing towards sustained improvement in the PVC business. The other thing I would say is that when the export business is soft like it is now, where we're seeing year-to-date exports down 33%, which tends to be the last location of PVC production, that's indicative of a strong market. When there's not enough product to go around, we shouldn't see margins remain favorable for us. On the chlor-alkali side, the chlorine molecule itself is very tight, and so producers are seeking the highest-value outlets for chlorine molecules. As Vicki mentioned, our very diverse portfolio of chlorine derivatives allows us to really maximize the bag of these chlorine molecules through our chain of opportunities. Chlor-alkali production itself has been under pressure for the year simply because of a lot of both unplanned and planned outages. If you look at chlor-alkali rates, they're actually lower in '21 than they were in '20 year-to-date, running about 75% year-to-date versus 80% over the same period last year, resulting in about 6% less caustic production available this year versus last year. So caustic is quite tight, which is helping to improve prices. With it playing out into the schedule in the third quarter, we would anticipate further support for additional price increases in the caustic soda business. As you see, caustic for us tends to be something that moves with the global economy. As economies open up and travel restrictions ease globally, we should see additional demand in underlying sectors. As far as the key demand sectors in the second half, we see better demand in the alumina sector, the pulp/paper sector, water treatment and certainly the leasing sectors all improving in the third quarter. Both sides of the ECU are looking strong heading into the second half of the year. The underlying factors certainly are bullish for both of them as we move into 2022 and beyond.

And the follow-up is one of the key takeaways from earnings season is the emphasis investors continue to place on cash returns. And at this point, Occidental is more focused on deleveraging the business, which makes a lot of sense. Can you just remind us what your absolute debt target is? And then at what point or what milestones should we be thinking about the company shifting from a deleveraging approach to one of where you can reintroduce something like a dividend?

Yes. Certainly a topic of discussion. We depicted on the 13th slide of the deck, which was newly included, that we're essentially on a journey when it comes to cash flow priorities. After a lot of risk in 2020, to derisk the company in what I call a post-COVID world, between the stabilization of production, the slashing of our costs and refinancing near-term maturities, now we're making headway, as Vicki detailed, on our deleveraging process. We took a significant step forward with the upside tender in July, through both a combination of cash available, from strong production performance, the continued capital execution and diligent cost management and really the remarkable turnaround in Chemicals, all contributed to the success of that. Now we've retired about $12.7 billion of principal since the middle of '19 through that combination of our great cash generation and investor program. I think we'll continue to work towards the $2 billion to $3 billion post-Colombia divesture target that we've established. Looking forward, it's anticipated that the majority of free cash flow from the business will be the source of future cash for debt retirement. It's critical that we take advantage of elevated prices to deleverage the balance sheet because changes in the macro environment could affect or alter commodity prices, which would inhibit our ability to do that. Our path does remain focused right now on the top two priorities being that we're focused on in our list. The length of this path depends upon future commodity prices because they certainly impact the rate at which we're able to move down the path. I think the steps we've taken since March of '20 are all part of a long-term strategy around increasing value to our shareholders.

It's surprising to me how people continue to seek cash returns when there is the potential to shift 40% of your market capitalization between debt and equity in the upcoming year. That's really the essence of my question regarding these disposals and how you can expedite that process. I want to frame it this way: when you set the $2 billion to $3 billion target after Colombia, Brent was at $42 for that target. Clearly, it isn't at that level now. Could you provide an update on whether you anticipate exceeding the $2.3 billion on a pari passu basis with the oil price? Or are you still aiming for the $2 billion to $3 billion, considering you might achieve that with fewer assets given the current oil price situation?

At this point, we're not really prepared to change the goals that we've set out, although we feel very comfortable we will achieve the lower end of that goal. But Doug, you're exactly right. Given our portfolio, there could be other opportunities available to us to continue to optimize what we have today. And optimization to us is not just ensuring that you have the best quality assets in your portfolio, that you're putting your dollars where they generate the most value. It's also looking at the opportunities to do as we just did, which is to monetize where you see that the monetization is going to be far out into the future. It's not meaningful value for our shareholders today. We're constantly updating and optimizing our plans, looking at opportunities to create value sooner rather than later.

Vicki, I apologize for asking for clarification on this, but if you have the same number of assets, are you ahead of schedule then in terms of the absolute proceeds, again reflecting the fact that the oil price is higher?

We are on schedule with what we need to do. But with that said, given where oil prices are today, we're quite comfortable looking at opportunities as they come in. We still have opportunities coming in the door for various parts of our portfolio. We look at all of those very critically, and I think there are going to be situations that come up over the next 12 to 18 months that will provide us more opportunity to raise additional funds. We're in a position to be much more careful, or rather, opportunistic, to ensure that we get maximum prices for what we would sell. So as we review our portfolio and optimize as we go along, we're keeping that in mind.

And congratulations on the quarter. It's nice to see everything clicking for the first time in a while. I guess what I would like to maybe address are some of the metrics you're using that underpin the decision to move away from any sort of a hedging strategy and maybe getting back to thinking about from a debt-to-EBITDA, debt-to-cap, and maybe a long-term debt number you're more comfortable with. Just maybe all the pieces that have gone into it that sort of speak to where you are now versus where everything was 12 and 24 months ago.

Yes, that's a valid question, Roger. Traditionally, the company has not adopted a hedging strategy, believing that our exposure to commodities and oil prices would ultimately provide the best value for our shareholders rather than relying on hedges to generate value. This perspective shifted in 2020 when our leverage required us to implement some protection against declining prices, which proved effective and significantly increased our cash flow from oil hedges. We will continue to take an opportunistic approach to hedging, but as we assess our options, we are considering several factors. The primary factor is the cost associated with executing hedges. The costs of the hedges we used last year included a call provision this year, which has not been too expensive, but that could change. Additionally, it's crucial to consider how the hedge impacts our potential leverage to oil prices. We believe it's important to maintain manageable debt ratios, which is why we focus on reducing maturing debt when commodity prices are favorable. Taking control of our debt structure allows us more flexibility going forward.

I appreciate that. That's a good answer, and it just sort of gets to the reduced risk profile overall. I appreciate that. Maybe just changing directions with my other question a little bit here. The comment about being able to add the two rigs in New Mexico, with no impact on CapEx. I'm just curious if that reflects improved efficiency and productivity, as some of the other things mentioned about uptime on the pumping jobs. Vicki, just a question overall as you're seeing the evolution and continued productivity and efficiency gains out in the field.

Yes, it was a combination of the efficiencies of the current drilling program and also the utilization of existing facilities to ensure that we could shift our capital to two additional rigs without needing any incremental infrastructure expenditures. This has created a really good opportunity, the fact that our teams are continuing to improve what they're doing.

And Roger, on top of what Vicki just said, it's important to note, if you look at our activity profile, we're ramping down through the year. So we're not ramping up activity; we're not ramping down. We still went from 12 rigs down to 10, and today we're at 11. We're just flattening out that activity profile while keeping the capital budget the same.

Yes, Jeff, just to follow up on what you were talking about with the activity levels, as you look at the second half spending, your annualized second half spending is around $3.2 billion or so. Any initial thoughts around the 2022 CapEx levels? Would you be looking to keep it where it is?

It's a good question. As you know, Phil, it's a little early for us to forecast what 2022 looks like. We usually do that on our fourth quarter call. However, looking at our capital profile, that's $2.9 billion for the year; we've spent $1.3 billion in the first half. Several factors drive that, for example, our Chemistry business forecasted about $300 million, but they’ve spent a little over $100 million. Many of those activities are back-end weighted. On our Permian activity, you can see that of our $1.2 billion, we've only spent $500 million of that. The reason for that is many Midland Basin wells were front-end loaded. So it's more about where we're spending capital and the cadence of activity rather than it drastically changing. So I wouldn't read into an 800 quarter-type number being what we need for next year. We are seeing great improvements from an operational standpoint. The teams have exceeded expectations from an efficiency standpoint and continue to achieve new records. I don't believe that's going to stop. We're seeing our teams do amazing things on drilling and operations, achieving records again and again this year.

That makes sense. My next question, I guess, would be for Vicki. As you think about the EOR business moving forward, where would you say you are in terms of the opportunity to process anthropogenic CO2? And how should we think about the timing of potential updates from the company as we look ahead, say, the next 6 to 12 months around CCUS?

As you may remember, we have 2 billion barrels of resources yet to be developed in the Enhanced Oil Recovery business in the Permian and conventional reservoirs. We're excited that the Low Carbon business will provide us with either a very low cost or net-zero cost CO2 for these projects. The incremental for Enhanced Oil Recovery will probably come closer to the time of getting the first direct air capture facility online. We still have access to organic CO2 and will see minor increases as we continue to expand phases within the Permian EOR business. Significant improvement in escalation will occur as part of our low carbon strategy, making it a key contributor and growth engine as we go forward.

Vicki, one, just curious, you guys are definitely one of the very efficient operators in the Permian and have done a good job. In the past, you have formed some joint ventures, essentially trying to prove value forward and have someone to fund you. But going forward, with your balance sheet starting to get in shape and cash flow getting better, if you look at some of your peers, like Shell, is there a plan to maybe pool the Permian asset together into a giant joint venture where you wouldn't extract cash upfront but just drive really great efficiency gains going forward that leverages your technical expertise?

I think that's a great idea. We always look for opportunities to create value. For us, it's about creating value for our shareholders. The JV with EcoPetrol in the Midland Basin has been very successful for us. We may consider additional JVs in the Delaware Basin to continue to accelerate what we're doing. Partnering with others to obtain synergies and utilize our team's execution part is a strong opportunity. I'm proud of our team's performance; they're pushing the technology envelope and continuously finding ways to model and operate efficiently.

I'm just curious, Vicki, have you talked to any of your peers, the other CEOs? I mean, everyone seems to have a big ego and think their team is the best. Is that something that the industry is ready to embrace to create value?

There has been some discussion around that. Some are open to it, some are not. I think this needs to happen to maximize the value of the assets we and others possess today. I've had conversations with other CEOs about this, and the industry needs to change its paradigm about how business is done to attract investors back to the oil and gas industry.

A lot of people forget that our Permian position was built on one of those JVs. We bought the joint venture between what was Amoco, Shell, and BP, which was exactly that. Many of the people in the company are very well-versed in the benefits that come from joint ventures and continually look for those opportunities.

Vicki, following up, you mentioned some coordination between OxyChem and the decarbonization business. How quickly could something like this occur?

OxyChem is already involved in the design of the direct air capture facility, providing essential front-end engineering expertise. They're helping to drive this process. We're also leveraging their knowledge in using caustic potash and PVC products in the facility that will be crucial components. They're pivotal on numerous fronts, not just for the initial direct air capture facility but also through R&D innovation that can enhance future projects.

Lastly, is there an update on the rough timeline for the pilot project, capacity in terms of CO2, and how you’re planning to finance it?

The FEED study should be completed, and we aim for final investment decisions early next year, with construction beginning by the end of 2022. The facility is designed to capture 1 million tons of CO2 per year, making it the largest direct air capture facility globally. We’re discussing multiple funding opportunities with potential partners, including United Airlines, who will contribute capital and will take the low-carbon fuel produced by the captured CO2.

I want to thank you all for your questions and for joining our call today.