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Morningstar | Permian Pipeline Congestion Triggers Midstream Windfall for Oxy

Occidental delivered production of 681 mboe/d in the third quarter, which was 7% higher sequentially and well above the midpoint of prior guidance (665-687 mboe/d). And firmwide financial results were stronger than expected too, with adjusted EBITDA and adjusted EPS coming in at $2.9 billion and $1.77, respectively (beating consensus estimates of $2.7 billion and $1.55). The upside came despite substantially higher unit production costs and weaker realized prices in the U.S. region (due to pipeline congestion, and thus widening basis differentials, in the Permian Basin).  But while these spreads drag on upstream earnings, the firm’s midstream segment is a huge beneficiary. Total output from the Permian region was about 250 mbbls/d in the third quarter, and the firm’s U.S. oil differential jumped to $13/bbl from $7/bbl. The implied cost to the upstream business was therefore roughly $140 million. But at the same time, midstream earnings surged by about $550 million (excluding a one-time gain of about $900 million related to noncore asset sales).

The midstream windfall is likely to be short-lived, given the planned ramp in Permian takeaway capacity during the second half of 2019. However, the firmwide cost of sales (excluding chemicals) has now exceeded our $9/boe forecast for three consecutive quarters, even though upstream cash operating costs are trending lower. This indicates that the 2017 improvement was more cyclical and less secular than we previously thought. As such, we are now modeling $10/boe for the long-term average cost of sales, which is the primary reason for our decreased fair value estimate (now $67 per share, down from $73). Accordingly, the stock still looks slightly overvalued, even after the recent sell-off.