The oil and gas sector is a volatile place right now. There are opportunities if you know where to look, but there’s also a lot of danger.
A change in sentiment
From wellhead to gas station, the oil business has seen its fair share of volatility over the past few decades. The upstream sector, which partially consists of the companies that drill for and produce oil, is one that offers the highest risk and the highest reward.
For a while, investors accepted volatility as an inherent part of a cyclical commodity business. But financial markets are now tiring of an investment thesis that basically says the more money you spend, the lower the break-even price per barrel of oil. While there are advantages to this strategy, excess spending can leave a company with an unhealthy amount of debt, even if they are able to break even at $5 less per barrel than their competitor. This change in sentiment is one reason why we are seeing investment in upstream oil and gas fall to a 15-year low.
Few companies embody the dangers of high investment/high efficiency more than Occidental Petroleum. The company’s acquisition of Anadarko Petroleum, which was finalized in August 2019, could not have come at a worse time. Anadarko’s enterprise value was around the same as Occidental’s, so Occidental had to increase its debt load to pull off the deal. Shortly after, the pandemic hit, and oil prices briefly went negative before rebounding to the current price of around $40 per barrel. This price is still unprofitable, or barely profitable, for many oil and gas producers.
Occidental’s logic in acquiring Anadarko was that their businesses aligned in many ways, most notably the shale plays that have made the U.S. energy-independent with horizontal drilling and hydraulic fracturing. Occidental CEO Vicki Hollub claimed that Occidental is the best shale operator from an efficiency standpoint, so Anadarko’s rich portfolio of assets would fit nicely into Occidental’s business.
The deal sounds good until you realize the kind of financial shape it has left the company in. Occidental’s strained balance sheet has pressured the company to try and sell some of its assets, but there are few buyers in today’s weak market. In its first-quarter 2020 earnings call, Occidental noted that it’s having trouble selling assets, so it will take on debt and cut its dividend. Occidental was one of the first cash-strapped oil producers to cut its dividend. ConocoPhillips yields 4% and Occidental Petroleum yields 0.2% at the time of this writing.
ConocoPhillips is the largest independent oil and…
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