When BRENT/WTI crude oil contracts plummet in price, I invariably make money with a long/short strategy where I buy a low beta defensive supermajor (Exxon) and short high beta E&P shares (Oxy, Apache) or oil service icons Schlumberger and Halliburton.
The strategy has made money in the past month as Brent has lost almost $15 as global demand softens, the Iran war risk premium shrinks, net longs in the NYMEX West Texas futures markets liquidate, Saudi Arabian and Iraqi production tops 10 MBD and three MBD and global inventories soar to their highest levels since the 1991 Gulf War. This is not a crude oil correction. It is an oil price crash, a scenario I had outlined in this column in January as I ran the Opec/IEA numbers and gasped at the mathematical certainty of an oil glut once Saudi Arabia, the central bank of black gold, abandoned the Opec output quota system. As in 1986 and 1998, the world is on the precipice of a major oil crash.
Occidental Petroleum, or Oxy, shares have plunged from their 118 high last summer to 79 now as its crude oil production/reserves were swiftly devalued (ok, repriced) on Wall Street. Yet Oxy, once the flagship of legendary North Sea and Libya wildcatter Dr Armand Hammer, who had done business with every Kremlin leader from Lenin to Gorbachev, is a successful Big Oil driller and producer.
Its production growth metrics are an incredible eight to 10 per cent. Its compound annual rate of dividend increase is a fabulous 15 per cent in the past decade. Since Oxy is a classic high beta E&P, its shares plunge when oil prices fall. In Wall Street oil trading jargon, Oxy has huge upstream leverage but its production growth in California, the Permian Basin in Texas, North Dakota, Oklahoma and the Middle East makes it a must own in any energy portfolio.
The question, comme toujours, dear Brutus, at what price?
Oxy fell to 66 in last summer’s Wall Street nervous breakdown and Brent can well fall to the Saudi Oil Minister’s $100 target. Oxy has a lovely chemicals business, an onshore production growth franchise in the US with no geopolitical risk, massive footprint in the Arab oil consortia in Qatari LNG, Iraq, Libya, Abu Dhabi, Bahrain and Oman. No less than one third of Oxy revenues derive from its vast footprint in the Arab world and North Africa. Oxy is the largest oil producer in Texas, North Dakota owns multi-billion dollar networks on pipelines and is among the world’s biggest traders of oil and gas.
The correction in Oxy has been brutal (lovely short for Energy Boy). The market cap of Oxy has now fallen to $66 billion and the dividend yield is 2.7 per cent. Has Oxy hit bottom? No. There are 5.3 million shares sold short and rising. I can easily see Oxy trade down to new lows at 62-64 if Brent/WTI keeps falling. Yet when I value Oxy’s oil reserves and production even at $90 Brent, its chemical, pipeline, gas to liquids and LNG business, its drilling acreage, its incredible cash flow per barrel margin production growth, I can project a path for the shares that is more Panglossian is this best of all possible worlds. Cash flow growth alone has driven Oxy’s valuation multiple metrics lower. It is never easy to buy an ugly duckling energy share during an oil and gas crash and I do not recommend a long Oxy at this point. Yet at 8 times forward earnings and 3.4 times enterprise value/Ebitda for a 21 per cent ROE oil and gas major with a 150 per cent reserve replacement ratios and 3.38 billion barrels oil equivalent in reserves. Oxychem alone is worth at least $12 a share. In the UAE alone, Oxy has a joint venture with Mubadala and partnered with Adnoc to develop the elephant Shah Field. Oxy is a beauty but only at the right price.