Occidental Petroleum (OXY -0.15%) stock has been stuck going sideways for months. One year ago, shares traded for roughly the same price they trade at today.
In 2024, Occidental stock could finally take off. Under the hood, the financials remain strong. A big catalyst toward the end of the year could add significant value. And with climate change a growing concern among major institutional investors, Occidental stands to take attention away from its competition for years to come.
Exactly how much upside could there be in 2024?
It all starts with a solid foundation
The biggest advantage Occidental has right now is ample free cash flow to direct toward whatever action will accrue the most long-term shareholder wealth.
In the third quarter alone, Occidental produced $1.7 billion in free cash flow. It used $600 million of this extra cash to repurchase common stock, with another $342 million dedicated to redeeming preferred shares. That still left more than $700 million for capital expenses and debt reduction, with the remainder padding the company's cash pile.
This tremendous cash flow is not an accident. For years the company has focused on relatively high margin properties. Occidental's production portfolio currently has a breakeven of under $50 per barrel, well below its peer average . On a corporate level, its wells have an average decline in production per year somewhere between 20% and 25%. That's high for oil producers in general, but roughly in-line with other shale producers.
Despite high free-cash-flow levels, share price weakness has left Occidental stock with an attractive free-cash-flow yield. Right now, for every $100 invested in the stock, shareholders are accruing roughly $10 in free cash flow every year. That figure has declined in recent quarters, but should get a big bump in the second half of 2024.
OXY Free Cash Flow Yield data by YCharts
A potential $1 billion bonus
In December, Occidental agreed to acquire CrownRock for $12 billion. CrownRock owns shale assets in the Permian basin, a region Occidental knows well. CrownRock's assets already produce oil and gas, meaning it won't be long before Occidental begins to earn a return on its investment. In the first year, management believes the acquisition will add around $1 billion to its free-cash-flow generation.
The deal is not without risk. CrownRock's breakeven is currently between $50 and $60 per barrel. With oil prices around $80 per barrel, that's not an issue right now. Should oil prices head lower, however, Occidental could be left with unprofitable assets. More than half of Occidental's current production, for comparison, can still be profitable even with oil prices below $50 per barrel. It should also be noted that the acquisition of CrownRock would increase Occidental's average well decline rate. CrowdRock's 35% average well decline rate is relatively attractive versus other properties targeting similar areas, but it is still a steep curve compared to more conventional plays.
The acquisition was also recently delayed after the FTC requested additional information from Occidental. Still, management believes the purchase will close by the second half of 2024. As long as oil prices remain at or above current levels, Occidental will only add to its free-cash-flow generation. It can use that money to buy back more stock, raise the dividend, or invest in emerging growth opportunities like carbon capture.
Carbon capture is the future of Occidental stock
Money manager BlackRock controls more than $9 trillion in assets. The market listens closely whenever its CEO, Larry Fink, offers his opinion. In 2020, Fink warned other CEOs that climate change will be "a defining factor in companies' long-term prospects."
This wasn't a matter of philosophy for Fink, but a matter of money. Companies that ignore climate change, he believed, will face a gradual decline in investor interest, raising the cost to do business.
Oil companies have been in the spotlight following Fink's letter. In the past, stocks like Occidental might have traded at much higher valuations given the ample free-cash-flow generation. Today, however, investor appetite for fossil fuel producers is relatively lower. That's why Occidental is investing in another business that could propel its growth for decades to come. That business is carbon capture.
Whenever oil or gas is burned, the result is atmospheric carbon, the major contributor to climate change. But what if oil and gas producers like Occidental sequestered this carbon back into the ground? Instead of an oil and gas producer, the company would become a carbon management business. That's exactly what Occidental is aiming to become.
The transition won't be easy, nor cheap, but there are some reasons to believe it's possible. Putting carbon into the ground uses much of the same infrastructure as extracting it. Occidental already has many of the assets needed to sequester carbon, yet it still requires a way to gather the carbon for sequestration. That is why it initiated two pilot projects seeking to capture carbon onsite directly through the air, a process called direct air capture, or DAC. DAC is currently not economically viable, but proponents believe costs will continue to fall as the technology scales and improves .
If successful, Occidental's DAC projects could position the company as a top choice for energy investors seeking to hedge their regulatory and social risk. While expensive, DAC sequestration has the advantage of being long lasting. Sequestering carbon in a forest only lasts for as long as the forest remains. Carbon captured in the air and sequestered deep in the ground, however, is nearly permanent. With integrated carbon sequestration capabilities that produce long lasting results, Occidental can arguably attract more investor interest in a future where markets grow worried about fossil fuel producers with unmitigated externalities.
Occidental's carbon capture business will take years to build out. But with high levels of current and expected free cash flow, shares should have limited downside while the carbon capture business attempts to scale.
