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Morningstar | Reversing Our Enthusiasm on Oxy After a Closer Look at Its Permian Well Performance

When Occidental agreed to acquire Anadarko Petroleum for $57 billion, we were enthusiastic at first, even though the proposed consideration reflected a takeover premium of more than 60%. As a result, we initially raised our fair value estimate for Oxy to $64 per share on May 10. This was primarily due to 1) the concurrent agreement to sell Anadarko's Africa assets to Total for $8 billion, a premium to our intrinsic value estimate, and 2) the potential for Oxy to juice the value of Anadarko's Permian assets by applying its technical prowess to improve the latter firm's pedestrian well performance.

Since then, our enthusiasm on the latter point has cooled. There's no question that Oxy is one of the leading operators in the basin (either due to favorable acreage, technical leadership, or more likely a combination). However, our earlier analysis was skewed by Occidental's extremely impressive initial production rates and did not sufficiently capture the downside from its very high decline rates. In the first few months of production, Oxy extracts more oil from its wells on average than any other operator. But in contrast to what we were previously modeling after about a year on line, the typical daily rate falls below the basin average due to steep upfront declines. Cumulatively, Oxy wells are still a little better than basin average even after 18 months on line, but it is no longer one of the top performers. Incorporating higher decline rates weighs heavily on our valuation. As a result, we have lowered our fair value estimate to $50 per share.

For more detail on the complex topic of Oxy's shale decline rates, look out for our upcoming special report.