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The Best Next Move for Occidental Petroleum Corporation

Photo credit: ConocoPhillips. 

Occidental Petroleum (NYSE: OXY  ) is in the middle of a major strategic shift. The company is selling off noncore assets and using that cash to buy back its stock. While that should boost earnings per share, the company can't sell assets forever -- it needs to do something to jump-start organic growth. That's why I think it's time for Occidental Petroleum to follow peers such as ConocoPhillips (NYSE: COP  ) and Halcon Resources (NYSE: HK  ) and focus on the boom in North American shale production. Here is an easy two-step plan the company could follow to achieve that result. 

Step No. 1: Invest in assets already in place
ConocoPhillips' North American shale assets fueled the company's growth this past quarter. While overall production was up just 3% year over year, even that wouldn't have been possible if not for the 41% year-over-year surge in production in the Eagle Ford and Bakken shale plays. Occidental Petroleum today lacks such growth assets, but it has shale potential thanks to a massive position in the Permian Basin.

Occidental Petroleum is exploring its potential in the basin, which is also one of ConocoPhillips' current areas of focus. So far Occidental has drilled 18 horizontal wells in the Midland Basin portion of the play, with a dozen of those wells being drilled this year. These wells have an average initial production rate of 750 barrels of oil per day, or BOE/d. That was achieved with an average lateral length of 6,000 feet, but piloting wells with lateral lengths of up to 10,000 feet should help increase those production rates, as well as Occidental's economic returns.

Occidental Petroleum is also testing its acreage in the Delaware Basin to the west and its acreage in New Mexico. As the following slide shows, the company has a large acreage position across the basin just waiting to be developed.

Source: Occidental Petroleum Investor Presentation (Link opens a PDF).

As that slide notes, the company is gradually shifting toward horizontal drilling in the Permian Basin. Because of this it sees this segment producing 13%-16% production growth in 2014, with the potential to deliver 20% annual production growth in the years ahead. This makes it clear the Permian Basin is becoming the cornerstone asset of Occidental's domestic business.

That being said, a one-basin wonder isn't what investors are looking for these days. This is why I think the company needs to boost from its positions in the Eagle Ford shale, Bakken, and midcontinent. The company has acquired 176,000 net acres in South Texas, along with 335,000 net acres in the Bakken region, but at this point none of those assets are driving meaningful production growth for Occidental.

Step No. 2: Use noncore sales to buy a shale driller
Occidental Petroleum could supercharge its unconventional production growth in those plays by acquiring a major shale driller. With the cash flow it's generating from noncore asset sales, Occidental Petroleum could easily afford to buy a shale-focused rival. Halcon Resources, for example, is known to be on the auction block. The company has solid positions in the Eagle Ford and Bakken, which are expected to fuel a 61% production surge for Halcon this year. Halcon also has a compelling position in the oil-rich Tuscaloosa Marine shale.

Source: Halcon Resources Investor Presentation (Link opens a PDF).

In addition to the future drilling locations acquired by such a buyout, Occidental Petroleum would add the technical expertise of the purchased company, which could help it do a better job unlocking its position in the Permian Basin and its shale acres elsewhere. Meanwhile, Occidental's strong cash flow could accelerate the drilling plan of the acquired company, enabling it to move the needle on production growth.

Investor takeaway
Occidental Petroleum's strategic initiatives are a good first step in the company's plan to create value for its investors. However, the company can do more. An emphasis on shale, through a focused effort in the Permian Basin and acquisition of a shale-focused driller such as Halcon Resources, could enable Occidental Petroleum to follow the growth pathway that is benefiting ConocoPhillips these days.

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Read/Post Comments (2) | Recommend This Article (3)

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  • Report this Comment On May 16, 2014, at 1:47 PM, HoerthCM wrote:

    That's a really cool idea. Never thought of that. Personally, if Oxy splits off and is a one basin wonder, Permian pure-play, I will be backing up the truck: Not only will the company have excellent horizontal drilling prospects, it will also have fantastically profitable CO2 operations with which to fund development and pay a big dividend.

  • Report this Comment On November 14, 2014, at 8:01 PM, PetEng wrote:

    Respectfully I completely disagree with the author's recommendation. To invest in shale plays is a poor business model. Especially when the basin has been discovered, and those late to the party pay very high lease costs to participate.

    Second, the cost of drilling and frac'ing the horizontal wells needed to develop the shale plays is significant relative to the potential profit, and with the steep declines, the requirement to continually invest never goes away.

    In a low oil price environment, this is a recipe for failure, and history shows that the oil price is difficult to predict correctly.

    The positive to Oxy is they have a significant revenue stream from conventional production, and are experts in Enhanced Oil Recovery, which can extend the life of an oil field by half again.

    Second they are very good at maintaining their cost structure per bbl low. This works well in a high $/bo environment and keeps the company profitable in a low $/bo environment.

    Unfortunately, uninformed investors advocate all too frequently changes in companies that are for short-term flash, but in the end reduce value of the assets, by raising costs, etc.

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Matt DiLallo

Matthew is a Senior Energy and Materials Specialist with The Motley Fool. He graduated from the Liberty University with a degree in Biblical Studies and a Masters of Business Administration. You can follow him on Twitter for the latest news and analysis of the energy and materials industries:

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