Is Occidental Petroleum Corporation at Risk In Iraq?

Occidental Petroleum Corporation’s interests in Iraq represent a minimal share of its production and an even smaller share of its earnings.

Jun 25, 2014 at 11:07AM

Recent violence in Iraq has elevated the threat to Western oil companies with operations in the country. While Iraqi oil production -- concentrated mainly in the southern part of the country and the northern Kurdistan region -- has so far been unaffected, continued unrest could cause some oil majors to scale back their operations.

One company with operations in Iraq is Occidental Petroleum (NYSE:OXY). Let's take a closer look at the company's exposure and whether or not it's a threat to its production and earnings.

Linn Energy Permian

Photo credit: LINN Energy LLC

Occidental's Iraq exposure
Occidental's presence in Iraq is mainly through a 20-year production-sharing contract with the South Oil Company of Iraq to develop the Zubair field, one of the world's largest oilfields located in southern Iraq. In 2013, Iraq contributed approximately 17,000 barrels of oil equivalent per day (boe/d) to Occidental's net production, representing just 2.2% of company-wide production of 763,000 boe/d last year.

Further, the earnings contribution of Iraqi production is even smaller due to Oxy's relatively high operating costs in Iraq. Under the terms of its production sharing contract, Occidental receives only a small remuneration fee per barrel after cost recovery. As such, its Iraqi volumes are some of the least profitable per barrel across its global portfolio.

Indeed, the company has been marketing its Middle East and North Africa (MENA) business since October of last year, as part of its restructuring strategy to become a smaller, more focused company with less exposure to geopolitical risk.

Planned MENA asset sale
According to a December report by Reuters, three state-owned Gulf firms -- Abu Dhabi's Mubadala Development, Qatar Petroleum, and Oman Oil -- expressed interest in purchasing a 40% stake in Oxy's MENA assets. But the talks have been held up due to political dissension between the bidders due to Qatar's support of the Muslim Brotherhood.

In any case, Oxy's MENA business is worth about $22 billion, meaning a 40% stake would be worth between $8 to $10 billion, according to Citigroup. While growing unrest in the region likely won't help Oxy receive a fair price for its assets, I think the sooner the company finalizes a sale, the better. Oxy can use the cash to further pay down its debt and buy back even more shares.

Better opportunities elsewhere
Oxy also has far better opportunities in the U.S., mainly in West Texas' Permian Basin, where it is one of the largest and most successful operators. It commands approximately roughly 1.9 million net acres in the Permian and accounts for nearly a fifth of basin-wide production. Over the past year or so, it has done a fantastic job of improving its returns from the play through a careful focus on cost reductions.

Going forward, Oxy plans to boost its Permian spending by around $450 million this year mainly to drill more horizontal wells in emerging plays like the Wolfcamp shale. At the same time, three major projects slated to come online this year -- the Al Hosn gas project, the BridgeTex pipeline, and the New Johnsonville chlor-alkali plant -- will provide a huge boost to Oxy's earnings and cash flows. Once fully operational, these three projects should generate at least $700 million in operating cash flow each year.

Lastly, Oxy's asset sales will allow the company to continue paying down debt and buying back shares. Oxy has already repurchased some 20 million shares and plans to repurchase an additional 26.5 million shares as part of its current buyback program. Once it completes the separation of its California unit and monetizes its remaining interest in the Plains pipeline, the company expects to be able to further reduce its share count by 40 million to 50 million shares. Add it all up and Oxy could reduce its share count by 90 to 100 million shares, representing about 12% of its current outstanding shares.

Investor takeaway
Iraq represents a relatively small portion of Oxy's company-wide production and an even smaller share of its earnings. Investors should pay closer attention to the company's Permian Basin operations and its progress with its restructuring strategy. Assuming Oxy can successfully execute on this strategy, it should be able to deliver much stronger earnings and cash flow growth in the years ahead, which, combined with its ambitious share buyback program, should drive stronger returns for shareholders.

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