In an April 2 research note, analyst Pavel Molchanov guesstimated the potential profitability from Occidental Petroleum Corp. (OXY:NYSE) going carbon neutral with respect to its enhanced oil recovery (EOR) practice.
Molchanov's self-described "thought experiment" follows the announcement by CEO Vicki Hollub that Occidental has set the goal of eventually becoming entirely carbon neutral, a first for a U.S. oil and gas producer.
The analyst explained that an oil and gas producer emits carbon dioxide directly and indirectly. For Occidental, direct emissions result from its operations, specifically CO2 injections at mature oilfields, rigs, trucks and pipelines to enhance oil recovery. Indirect emissions result from the use of petroleum as fuel in cars and trucks.
"Occidental's stated target of achieving full carbon neutrality notionally encompasses both of these elements, albeit with no formal timetable," Molchanov wrote. "We doubt that the company could get there until 2030+, but in the meantime, offsetting the direct emissions represents the 'low-hanging fruit.'"
Regarding CO2 injections for EOR, the practice is only done in conventional drilling today, and is more common in the mature basins. The Permian, for instance, is a "massive user," Molchanov described. Because most of the CO2 used in the Permian is naturally occurring (extracted and transported via pipeline) versus man-made (derived from carbon capture and sequestration), "EOR's carbon intensity (emissions per barrel) is traditionally quite high." Companies generally use naturally occurring CO2 because it is cheaper to source.
As for Occidental, Molchanov pointed out, it uses 49 million tons of CO2 per year in the Permian, where EOR comprises 22% of the company's total production. Further, Occidental is the biggest EOR operator in the basin. So to achieve carbon neutrality, the company would have toreplace all or most of the naturally occurring CO2 it uses with man-made, or captured, CO2.
Doing so, however, presents logistical problems, Molchanov noted. Because West Texas doesn't have many CO2 emitting entities, such as power plants, refineries and the like, long-distance pipelines would have to be built to transport large quantities of captured CO2 into the area—from, say, the Gulf Coast or farther north.
To determine the possible profitability of a switch to captured CO2, Molchanov indicated, one must take into account that in 2018, Congress significantly increased the Section 45Q tax credit for the use of carbon capture in EOR, up to $35 a ton from $10 a ton, and did away with the previous volumetric cap. Whereas the tax credit goes to the source of the CO2, Occidental would benefit indirectly by getting the CO2 at a reduced cost or no cost or even being paid to take it.
Molchanov explored such a scenario. Were Occidental to attain 100% captured CO2 in the Permian and obtain the captured CO2 it needed for free, it would save the $450 million per year (about $9 per ton of CO2) it currently pays in injectant costs. Assuming all else is equal, such a savings would boost earnings per share by $0.45 on an after-tax basis. In a case where Occidental was paid to take the CO2, the upside would be even greater.
"Our sense is that this entire theme is below the radar for most Occidental shareholders, and we look at it as an essentially free, albeit low visibility, option," Molchanov commented.
Raymond James has a Strong Buy rating but no target price on Occidental. It is trading at around $68.04 per share.[NLINSERT]
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Disclosures from Raymond James, Occidental Petroleum Corp., April 2, 2019
Analysts Holdings and Compensation: Equity analysts and their staffs at Raymond James are compensated based on a salary and bonus system. Several factors enter into the bonus determination, including quality and performance of research product, the analyst's success in rating stocks versus an industry index, and support effectiveness to trading and the retail and institutional sales forces. Other factors may include but are not limited to: overall ratings from internal (other than investment banking) or external parties and the general productivity and revenue generated in covered stocks.
The analyst Pavel Molchanov, primarily responsible for the preparation of this research report, attests to the following: (1) that the views and opinions rendered in this research report reflect his or her personal views about the subject companies or issuers and (2) that no part of the research analyst’s compensation was, is, or will be directly or indirectly related to the specific recommendations or views in this research report. In addition, said analyst(s) has not received compensation from any subject company in the last 12 months.
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