Fitch Affirms Occidental Petroleum's IDR at 'A'; Revises Outlook to Stable.
The primary catalyst for stabilizing the Outlook is the early completion of the company's Breakeven Plan and a materially improved FCF outlook. Under that plan, OXY expects to fund its capex and dividend with no upstream growth at $40 WTI, and with 5%-8% upstream growth at $50 WTI. A key plank of the plan was the additional cash flow from an 80,000 boepd increase in high margin Permian Resources production. In Q2, OXY achieved that target three quarters early, with average Q2 Resources production increasing to 201,000 boepd, and a Q2 exit rate of 213,000 boepd. The company also logged very strong results in its midstream and marketing and chemicals segments and expects to see additional liquidity through the pending sale of its Centurion Pipeline and Ingleside export terminal.
KEY RATING DRIVERS
COMPLETION OF BREAKEVEN PLAN MITIGATES DIVIDEND CONCERNS: The main credit concern for OXY is its large dividend and associated FCF gap at lower oil prices. OXY's dividend ($2.4 billion) was not cut during the downturn, unlike a number of other E&Ps that acted earlier in the cycle to help restore FCF neutrality. OXY has mitigated these concerns through the early completion of its breakeven plan, which centers on the addition of 80,000 boepd of higher margin production from Permian Resources to help plug the FCF gap. Under this plan, OXY expects to be able to fund its capex program and dividend with no upstream growth at $40 WTI, and fund the dividend plus 5%-8% upstream growth at $50 WTI. The 80,000 boepd production target was achieved in Q2 '18, versus original guidance of Q1 2019. Q2 Permian Resources production was 201,000 boepd, up 24,000 boepd above Q1 levels and 46% y-o-y. The exit rate in Q2 was 213,000 boepd. Most of the recently announced increase in 2018 capex will be spent in Permian Resources, which is expected to further accelerate growth in 2019.
ANCHOR POSITION IN PERMIAN: The Permian is OXY's key asset and its main growth driver. OXY has one of the largest land positions in the Permian at 2.5 million net acres. In Q2, its total Permian production was 354,000 boepd, split between Permian Resources (201,000 boepd) and Permian EOR (153,000 boepd). Permian Resources remains the company's key growth plank, given the opportunities for further efficiency gains in horizontal drilling. In terms of land, 1.4MM acres were held at Resources, including a subset of 650,000 higher value acres within the Delaware and Midland basins. At June 30, 2018, OXY had an inventory of 10,574 total horizontal drilling locations at Resources, including a 17-year inventory with a full cycle BE below $50 (assuming a 10 rig program). The company's wells have below average proppant use per stage foot, and the average lateral in the Permian Resources portfolio in Q2 was 7,800 feet, suggesting that there is meaningful room for further gains from longer laterals. Fitch expects the number of drilling locations to rise as further technology improvements are implemented across the portfolio and the company completes additional acreage optimizations.
INTEGRATED PRODUCER: OXY enjoys modest but meaningful integration benefits through its chemicals segment (OxyChem), which has a top three position in most basic chemicals it produces in North America (chlorine, vinyl, PVC, caustic soda) and through its midstream segment (gas processing plants, pipelines, CO2 infrastructure, storage, power generation and gas marketing businesses). Chemicals has historically contributed strong FCF given its limited reinvestment needs, which the company has been able to redeploy elsewhere. Contributions from the Midstream segment were weak in 2017 due to compressed crude spreads and foreign pipeline downtime but have since sharply rebounded.
SHARP REBOUND IN METRICS: OXY's credit metrics reflect its improved performance. As calculated by Fitch, LTM leverage at June 30, 2018 declined to 1.5x versus 1.9x in 2017 and 2.9x in the 2016 trough. Interest coverage rose to 18.5x over the same period, from 15.0x in 2017 and 11.0 in 2016. In addition to strong upstream performance, enhanced contributions from chemicals and midstream contributed to increased cash flow. In Q2, chemicals benefited from stronger contributions from the Ingleside cracker, from the 4CPe plant which produces environmentally friendly refrigerants, and improved product pricing for caustic soda. Chemicals segment pre-tax income rose to $317 million versus $230 million y-o-y. Midstream & marketing pre-tax segment income rose to $250 million versus $119 million y-o-y with the main drivers higher marketing revenues linked to sharply wider Permian to gulf coast crude oil spreads, higher marketing volumes, and an earlier increase in Al Hosn volumes linked to plant debottlenecking.
ASSET SALES: OXY has agreed to sell off several non-core midstream assets, including the Centurion oil gathering system and long-haul pipeline, a southeast New Mexico oil gathering system, and the Ingleside export terminal in Corpus Christi. Sales proceeds of around $2.4 billion are expected to be received in Q3. The sales are not expected to impact market access for OXY's Permian production, as the company retained long-term takeaway capacity out of the Permian, including 670,000 bpd of Midland to Gulf Coast commitments over the 2019-2020 timeframe, and 450,000 bpd of export rights out of Ingleside to 2030. The divested assets accounted for $180 million in 2017 EBITDA and $140 million in capex. OXY intends to use excess cash flows to reinvest in the business, as well as for higher shareholder distributions. 2018 capex was increased from $3.9 billion to $5.0 billion.
PRODUCTION SHARING CONTRACTS (PSCs): Production sharing contracts (PSCs) associated with OXY's overseas investments are a credit positive in a price downturn, as PSCs help stabilize FCF due to the relatively rapid repayment of operating expenses and capex from a recovery pool of cost oil. This cost oil is paid to the contractor before profits are paid out to the state, providing a cushion in a low oil price environment. PSCs are also countercyclical in terms of reserves and production. As the price of oil declines, the volume of production and reserves a private partner is entitled to book to cover its costs rise, and vice-versa when oil rises. In 2017, OXY's PSCs included investments in Oman, Qatar, and Colombia.
LOWER GEOLOGICAL RISK: OXY tends to have lower geological (exploration) risk than a number of other operators in the upstream due to its focus on enhanced oil recovery techniques (EOR), which extract oil from known fields like the Permian and other mature fields using CO2 floods, steam floods, and other techniques.
HIGH EXPOSURE TO LIQUIDS: OXY has one of the highest exposures to liquids among its peers. As calculated by Fitch, approximately 78% of OXY's 2017 production and 75% of reserves were liquids, giving it a better cash generation profile than gassier peers. Most of these liquids are higher value oil vs NGLs, and a significant portion of international pricing is Brent-linked. Cash netbacks have historically been strong based on this profile. Most of the expected growth in output will come from development of high-margin Permian Resources, which should provide additional cash flow uplift to the portfolio. The company has ample takeaway capacity out of the Permian.
OXY's credit profile shares characteristics with both independent E&Ps and larger integrated oil companies. Its 'A' rating reflects its intermediate status between these two groups. In terms of size and scale, at 639,000 boepd and 2.6BN boe of proved reserves it ranks in line with larger independent E&Ps such as Devon (BBB+/Stable) and Anadarko (BBB/Stable), but is smaller than ConocoPhillips (A/Stable) and Total SA (AA-/Stable). Upstream diversification is above-average versus independent peers but below that of larger integrateds, and includes positions in the U.S., Colombia, and a sizable stake in Middle Eastern countries, which is a differentiating factor for a company this size as well. The overall quality of the resource base is strong, given OXY's anchor position in the highly economic Permian (2.5 million net acres, ample takeaway capacity out of the basin), and high liquids exposure. Integration with chemicals and midstream also sets OXY apart from independent E&P peers. OXY's dividend policy is aligned with that of bigger integrateds, given its large payout. OXY's projected volume growth is robust for its size, and compares favorably with the low growth profiles of many integrated oil companies.
Fitch's key assumptions within our rating case for the issuer include:
--Base case WTI oil prices of $65/bbl in 2018, $60/bbl in 2019, and $55/bbl in 2020 and the long run;
--Base case natural gas price of $2.75/mcf in 2018, and $3.00/mcf in 2019, 2020, and the long run;
--Production of 655,000 boepd in 2018, 713,000 boepd in 2019, and 770,000 boepd in 2020;
--2018 capex of $5.0 billion, stepping down to approximately $4.5 billion by 2020;
--Low dividend growth of 2% in 2018, which accelerates across the forecast in line with higher E&P volumes;
--Net asset sales of approximately $2.7 billion in 2018
--Share buybacks totalling $3.7 billion across the forecast.
Future Developments That May, Individually or Collectively, Lead to Positive Rating Action
For an upgrade to 'A+':
--Increased size, scale, and diversification;
--Sustained E&P debt/flowing barrel below $8,000; sustained debt/EBITDA below 0.8x;
--Continued adherence to conservative financial policy and dividend payout.
Future Developments That May, Individually or Collectively, Lead to Negative Rating Action
For a downgrade to 'A-':
--Material decrease in diversification through asset sales;
--Sustained debt/EBITDA above approximately 1.7x; sustained E&P debt/flowing barrel above $14,000;
--Incremental debt funding to pay for shareholder distributions.
OXY's liquidity is good. Cash on hand at June 30, 2018 was just under $1.4 billion, and the company's $3.0 billion credit facility (maturing January 2023) remained untapped, for total liquidity of approximately $4.4 billion. Recently announced asset sales, including the Centurion pipeline and Ingleside export terminal, are expected to result in proceeds of around $2.4 billion in Q3. In addition, the company has other sources of liquidity at its disposal, including liquidation of its stake in Plains GP Holdings (PAGP), and liquidation of non-core Permian acreage from its large land inventory of 2.5 million acres.
Near-term maturities are light following the company's recent issuance and refinancing and include nothing due in 2018 following repayment of $500 million in 1.5% notes earlier this year, $116 million in 9.25% notes due in 2019, and nothing due in 2020. In 2021 the company's 4.1% $1.25 billion 2021 note comes due.
OXY's other obligations are manageable. OXY's Asset Retirement Obligation (ARO), linked mostly to remediating well sites, stood at just over $1.3 billion at YE 2017, down slightly from levels seen the year prior, with the decrease due largely to the impact of dispositions. Rental expense associated with operating leases for 2017 was $278 million, versus $237 million in 2016. Rental expense was primarily associated with transportation equipment, power plants, machinery, terminals, land, and office space.
At YE 2017, OXY's environmental reserves stood at $865 million and covered 148 remediation sites. Reserves for 16 of the sites listed above exceeded $10 million each, with the remainder significantly smaller. The list also included three sites associated with the CERCLA (Superfund) National Priorities List (NPL): Love Canal, Diamond Alakali, and an Ohio chemical plant. The latter two and other remediation sites were defended and indemnified by Maxus Energy Corporation, a subsidiary of YPF. Maxus Energy filed for bankruptcy in mid-2016, leading OXY to revise its reserves up significantly in 2016.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Occidental Petroleum Corporation
- Long-Term IDR at 'A';
- Senior Unsecured Revolver at 'A';
- Senior Unsecured Notes at 'A';
- Commercial Paper at 'F1';
- Short-Term IDR: 'F1'.
The Rating Outlook has been revised to Stable from Negative.
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|Publication:||Daily the Pak Banker (Lahore, Pakistan)|
|Date:||Jan 1, 2019|
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