Occidental Petroleum(NYSE: OXY) is one of the country's largest oil and gas producers. It recently increased its exposure to the oil market by acquiring CrownRock in a $12 billion deal. That acquisition will add $1 billion to the company's annual free cash flow, assuming oil prices average around $70 a barrel. Unfortunately for Occidental, crude prices have recently slumped below that level.
While lower oil prices will affect the company's cash flow in the near term, they'll have less of an effect on its earnings in the future. Here's what's driving its reduced reliance on oil and gas to fuel its results.
Drilling down into how Occidental Petroleum makes money
Occidental Petroleum is a more diversified energy company than many of its peers in the oil patch. In addition to producing oil and gas, Occidental has a chemicals business, called OxyChem, and a midstream and marketing segment. However, the company currently makes most of its money from oil and gas production. For example, Occidental's oil and gas segment produced $1.6 billion of pre-tax income during the second quarter. For comparison, OxyChem's earnings were $296 million, and its midstream and marketing segment's earnings were $116 million.
Higher oil prices helped boost Occidental's earnings during the second quarter. Pre-tax earnings from the oil and gas segment were up $400 million compared to the first quarter, thanks to a 5% improvement in oil prices. The company also got a boost from higher oil and gas production, which exceeded the midpoint of its guidance.
However, oil prices have fallen sharply over the past few months. Crude was recently under $70 a barrel, well below the nearly $80 average it captured during the second quarter. Now the company's earnings and cash flow are likely to decline in the second half of this year.
The path to $1 billion (and beyond)
Occidental is working to mute the impact of oil price volatility by increasing its free cash flow from non-oil components. The company has a clear line of sight to add more than $1 billion of incremental annual free cash flow by the second half of 2026 from areas beyond oil and gas.
For example, its investment in Western Midstream Partners (NYSE: WES) could supply $240 million of incremental cash flow by 2027 as the master limited partnership (MLP) increases its distribution. Western Midstream recently provided investors with a monster raise of 52%, driven by acquisitions, asset sales to strengthen its balance sheet, and organic expansion projects. As the largest investor in the MLP, Occidental receives the lion's share of its lucrative and growing distribution payments.
In addition, Occidental Petroleum is repaying debt as it matures. The company expects to retire $3.7 billion of debt through 2026, which will reduce interest expenses by $180 million. Meanwhile, the company's midstream business has several high-cost contracts nearing expiration. As they expire, they should save the company about $400 million by 2027. Finally, OxyChem is investing heavily in plant enhancements and the modernization and expansion of its Battleground complex. These investments should add about $325 million to its free cash flow total by 2027.
On top of all that, Occidental is building out a carbon capture and storage business (CCS). It's currently constructing the STRATOS project, the world's largest direct air capture (DAC) facility, to extract carbon dioxide from the atmosphere. It expects to complete the project by the middle of next year. The company is commercializing STRATOS by selling carbon credits to customers desiring to offset their emissions. Occidental has several other DAC projects under development. In addition, it's working to develop sequestration hubs to permanently store carbon dioxide. Occidental believes it can eventually make as much money from CCS as it currently does from producing oil and gas.
Growing less reliant on oil
Crude prices are the main factor fueling Occidental's earnings these days. However, oil won't have as much of an impact on the company's earnings in the future. It has a visible path to add an incremental $1 billion to its free cash flow from non-oil sources by the second half of 2026. In addition, it's building out a CCS platform that could be a major future contributor. These catalysts will help reduce the volatility of the company's earnings in the future, which should make it a less risky oil stock.
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Matt DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends Occidental Petroleum. The Motley Fool has a disclosure policy.
