Back with us today is oil and gas specialist Callum Turcan on Occidental Petroleum’s decision to leave the oil fields in Qatar…
Occidental Petroleum Corporation (NYSE:OXY) produced 284,000 barrels of oil equivalent per day net from its international upstream operations during the first three quarters of 2018. That is equal to 44% of its production base, with that output coming from Qatar, the UAE, Oman, Colombia, and Bolivia. Recently Occidental Petroleum issued out a press release that stated it was going to let one of its big production-sharing contracts in Qatar expire. Let’s go over the significance of that event.
In the middle of October, Occidental Petroleum announced that it wasn’t going to extend the length of the production-sharing contract covering the offshore Idd El-Shargi North Dome in Qatar. Occidental Petroleum owns 100% of that concession which expires in October 2019. The field produced 53,000 barrels of oil equivalent net last year (even though Occidental owns 100% of the PSC, there is a big difference between net and gross production levels due to various adjustments). This is one of Qatar’s largest oil fields, keeping in mind the nation is primarily a natural gas exporting giant. Occidental had been developing the field since the 1990s and proven to be a very capable operator.
This news appeared to come as somewhat of a shock, but some context is needed to get an idea why management made this decision. For starters, renewing the PSC would have involved committing to extensive capital expenditures to extend the life of the field. In the press release, Occidental commented that the field was currently producing 51,000 BOE/d and was set to generate just below $300 million in free cash flow in 2018E (currently, annual cash flow is estimated at $500 million and capex is estimated at $200 million, which is subject to change going forward for a variety of reasons). At face value, it seems straight foolish to throw away FCF generation, but keep this statement in mind (emphasis added):
Beyond the capital expenditures required as per the new production sharing contract, often upfront payments need to be made to the host nation as part of these deals. The exact terms of these PSCs are usually not known for competitive reasons (for both governments and private enterprises), and this is the case across the globe. It isn’t clear what the exact terms would be if Occidental were to extend the PSC. I will also note that since this press release was put out, oil prices have moved considerably lower which likely reduces the FCF generation of the PSC.
Serious capex requirements
During Occidental’s Q3 2018 conference call, management noted that the firm is going to allocate capital that would have gone to Qatar next year elsewhere. Management stated that:
The last time Occidental launched a major project at the Idd El-Shargi North Dome was in 2013, which involved drilling 200 additional wells (producing, water injection, and water source wells) and constructing additional facilities to support those operations. At the time of the announcement, this was expected to cost over $3 billion. It appears that if the ISND concession were to be extended, Occidental’s annual capex commitment would have climbed well above $200 million.
Phase 5, as the 2013 project was known, helped Occidental maintain the ISND field’s output near its peak capacity of 100,000 bpd gross. It isn’t clear what the exact production rate of the ISND field is today, but Occidental noted the gross production of both the northern and southern portion (which is covered by a different PSC) came in at 91,000 bpd gross last year.
Most likely, output from the ISND field is in decline and a multi-billion investment would be required sometime in the near future to bring production back up to (or at least closer to) peak capacity. Occidental Petroleum apparently wants to pivot towards investing more in short-cycle onshore plays, due to the prolific nature of its unconventional wells in the Permian and the financial flexibility provided by these types of operations. The company is also a key petrochemical player in America and recently expanded its presence in Oman, which represent two additional growth avenues that this freed up capital could be directed to.
As an aside, the concession covering the Idd El Shargi South Dome field expires in December 2022. Last year, the field produced 4,000 BOE/d net to Occidental. Output from ISSD appears to be ticking up, as Occidental exited 2017 pumping 9,000 BOE/d gross from the field. Occidental will likely remain the operator of that concession until it expires, but we will have to see if management wants to extend that further (unlikely as things stand today).
Possible reasons for exiting
Occidental may have been encouraged to continue shifting towards its domestic operations due to the difference in economic dynamics between an American upstream project and an international upstream project covered by a PSC. Generally speaking, American oil & gas producers keep the lion’s share of the profits.
True, there are royalties (note these royalties go to the mineral rights owners, a private entity in most circumstances) and there are production taxes to consider, but the vast majority of an American upstream venture’s profits go to the private stakeholders. Under a production-sharing contract, that isn’t necessarily the case. Occidental’s PSC with Qatar was quite profitable, but note the government does get a much larger share of the spoils under those arrangements (especially when factoring in other tax components as well).
In other words, Occidental was faced with a choice. Management could choose to allocate capital towards developing a foreign conventional offshore field with a lower expected rate of return but also a lower chance of not being profitable, or invest in domestic unconventional onshore opportunities that have a higher expected rate of return but a greater chance of not being profitable. Differences in the standard deviation of the returns on such projects are why this is the case.
This news came as a surprise to me, as having a blended conventional and unconventional production profile can be quite useful when navigating turbulent energy markets. Even if the concession were to be extended, Occidental Petroleum Corporation would still have generated a modest amount of free cash flow from the venture according to management’s commentary on the issue. That points towards there being more to the story than simply higher capex commitments. Occidental Petroleum has a large international presence, so exiting one of its biggest PSCs could be indicative of something bigger. We will have to see how this plays out. Thanks for reading.