Over the past few months of my writing break, I have had time to look into individual stocks that have some interesting pricing or features, especially with the fall in the markets. I will likely produce other posts about stocks that I find very attractive, especially in the banking sector such as CUBI, BLX or BAP but today I wanted to focus on one stock that has received some attention as of late.
In past posts, I have discussed stock picks which have been picked up by Berkshire Hathaway but I don’t often like to do this. I like to avoid the general trend following which the media performs and new stocks acquired by Berkshire and its chairman Warren Buffet, are very popular financial fodder for click bait. People who often don’t have an investing strategy tend to follow what others are doing, many follow famous investors who have been successful in the past such as Buffet, which is why the media pours over new stock picks of his like a hawk.
However, for Occidental Petroleum (OXY) it wasn’t Buffet’s acquiring the shares that interested me but rather the insights from a quantitative trading blog called Quiver Quant, which advertises heavily on Tik Tok. One of the interesting strategies that this blog employs is that it follows the trading habits of congressmen and women, especially those that sit on important subcommittees. It also tracks the lobbying of different firms and recently OXY was found by the site to have paid about $20 million in lobbying last quarter, one of the highest amounts of any company, which was aimed at the recently passed Inflation Reduction Act.
Besides the big ticket items included in this bill such as the power for Medicaid to negotiate drug prices (long overdue) or a minimum corporate tax of 15% (how will this work with tax credits?), was a lesser publicized section on the 45Q tax credits.
There was some conflicting information on what exactly this credit entailed, so I looked at the latest quarterly report of OXY, as well as other sources to see the breakdown. In essence this tax credit will pay companies that recapture emissions they produce as well as pay companies which capture carbon from the air and store it underground.
Previously, this tax credit had already existed but only covered carbon which was produced by a company and recaptured. The previous tax credit given by the government was $50 per metric ton. With the new bill however, that increases to $85 per ton and crucially for OXY, adds a new segment for carbon captured directly from the air at $180 a ton.
The idea is to incentivize companies to start to capture and store carbon dioxide to offset the 31.5 billion tons of carbon dioxide emitted globally on an annual basis right now.
How This Relates to OXY
So why was OXY lobbying so hard for this? Well it turns out that, like other companies OXY has made a commitment to be carbon neutral by 2050. It sounds counter intuitive that an oil and gas company can be carbon neutral but the devil is in the details when it comes to OXY. This is good considering that their CEO Vicki Hollub, is a former engineer who knows something about what her company does on a day to day basis.
The carbon neutral strategy for OXY involves multiple steps. The first, which the company has been doing for some years now, is to pump carbon dioxide into the shale formations which it is tapping for extraction currently. This reduces the emissions per barrel and helps store carbon already in the atmosphere. But OXY is planning to go much further than that. OXY plans to be the global leader in carbon capture tech.
The company has announced $1 billion that they plan to spend to capture carbon directly from the air, or Direct Air Capture (DAC). Construction is starting on a facility in the second half of 2022, that can capture 1 million tons of carbon annually. The company plans to build 69 more of these facilities by 2035. Quiver Quant performed a back of the envelope calculation that said if we assume 70 facilities capturing 1 million tons a year times $180 a ton, this equated to $12.6 billion in revenue. Net revenue for all of 2022 was $26 billion, so this represents a new stream of business which could one day account for a third of revenue for the company, not to mention that we will likely be using oil and gas, as well as the chemicals the firm produces under its OxyChem brand. Keep in mind however that these figures have not been corroborated by OXY and the company guidance given could turn out to be even better as we will see.
The announcement of the DAC facility is even more impressive when you take into account that 1 million tons of carbon removal is 100 times larger than the amount of carbon all DAC facilities worldwide take out of the atmosphere according to the International Energy Agency. Besides the 1 million tons capacity for the first facility, the company set an explicit target to offset 3.68 million tons of carbon within the next year, which could lead to hundreds of millions in tax credits if this is coming from carbon storage, not a bad investment of $20 million if you ask me.
The back of the envelope calculation, like many back of the envelope calculations, is that simple though. In reality, the $180 a ton is paid for DAC which is stored in secure geologic formations. $130 a ton is paid for carbon which is captured and used, including in oil and gas fields. Crucially, the bill also makes these tax credits transferable to a third party. This could allow OXY to sell the tax credits at some point and recognize them as revenue as well. There is also a qualified carbon oxide (QCO) section which pays out $85 and $60 for QCO again based on where it is stored. More detail on the way the bill treats carbon capture can be found here.
What this means is we can’t assume that OXY will be getting $180 a ton times 70 million tons a year in 2035. The average revenue will depend on the source of the carbon and how it is stored, what we do know is that the carbon capture revenue per ton will be somewhere between $60 a ton and $180 a ton, much higher than the previous figures which the government offered before.
What is even more interesting is that digging into the notes of their sustainability report, OXY actually says that they only need 6 facilities to offset their own carbon emissions which are 60 million tons annually. This means that the DAC facilities envisioned may have a capacity of 10 million tons of carbon annually rather than 1 million tons. If this is indeed true (remember they have set the bar low by saying the new facility will capture 1 million tons annually) then 64 additional facilities capturing carbon from the air at $155 a ton (assuming a mix of lower paying credits and the higher paying DAC credits) could produce over $100 billion in revenue.
Cost Matters
Currently the net margin for the firm is about 8.8% which produced net income of $2.3 billion for shareholders in 2021. Due to higher oil prices, the firm has already raked in $2.1 and $3.1 billion in the first and second quarter respectively, more than doubling net income from last year. The main question, which some sources have pointed out, is that no one knows the cost of capturing and storing this carbon from operations or the atmosphere. We could assume a similar margin to their oil and gas operations, which would mean that in 2035 the firm could pull in about 4.8 times what they earned in 2021 based of of that $100 billion in revenue figure. In this scenario, carbon capture would be accounting for 79% of profits assuming oil profits remain flat from 2021 levels. But this is just a wild guess.
What we do know for sure is that there is a pathway now and dollar figures have been put on, capturing and storing carbon in specific areas beneath the ground. These will be geologic formations that are natural (best) as well as formations where the oil and gas was drained and then replaced with carbon (next best). This would put both the owners of land that can store this carbon, as well as the operators who can put it there, at an advantage. And it just so happens that OXY and another firm Berkshire Hathaway have been buying recently can stand to benefit from this: Chevron. Why? Because both these firms are the overwhelming leaders in land and lease ownership in the Permian Basin, which is currently the largest source of shale gas and oil in the U.S.
Both OXY and Chevron are stocks that have been heavily purchased by Berkshire Hathaway recently. With inflation and conflict keeping oil and gas high as well as on-shoring for many US products taking place due to the supply chain issues COVID exposed, it would surprise me to think that Berkshire is making a large bet on domestic oil and gas production. The carbon capture technology part of it may be icing on the cake.
While reading through the environmental report, I also noticed another company mentioned which has flown under the radar and that is the timberland company Weyerhaeuser (WY). WY is the largest landowner in the US and is currently leasing some of its land to allow OXY to store carbon underneath it. Whether this could provide a new revenue source to this relatively stagnant stock is another interesting takeaway from this investigation.
Conclusion
The potential for OXY remains very large but still murky. The company would need to provide cost figures if they are to convince shareholders that carbon capture and sequestration is indeed the future of the company. It takes a lot of determination to be in the lead in such a space though and OXY’s management should be recognized for their vision.
For investors, this one remains a wait and see in terms of green investment but the near future also seems to look bright for OXY with its Permian Basis assets and the prospect of high energy prices seemingly here to stay for the immediate future.
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