Despite an oil-weighed production mix and solid asset base, shares of Occidental Petroleum Corp (NYSE: OXY) have underperformed its peers over the past two years, largely because of escalating costs and disappointing production growth in California.
In late 2010 and early 2011, shares of Occidental Petroleum surged amid high expectations for unconventional drilling in the Permian Basin and Monterey Shale. With investors on the hunt for the next big shale play, the market began to privilege rapid production growth over strong free cash flow and solid returns on investment–Occidental Petroleum’s bread and butter.
Although Occidental Petroleum’s higher capital spending has translated into oil production that has increased in nine consecutive quarters, this growth hasn’t matched the expectations of investors seeking the huge initial production rates touted by operators in prolific shale oil and gas plays.
To worsen matters, stepped-up drilling activity has also led to a steady increase in operating costs and a disappointing loss of efficiency.
Between the first quarter of 2011 and the third quarter of 2012, Occidental Petroleum’s average production costs soared from $11.30 per barrel of oil equivalent to a high of $16 per barrel of oil equivalent. Although these investments achieved management’s objective of expanding hydrocarbon production, the associated costs constrained earnings growth and free cash flow.
Fortunately, efforts to refocus on improving operational efficiency are starting to pay off. In the first quarter of 2013, the Occidental Petroleum’s production costs declined by more than $1 per barrel of oil equivalent sequentially, suggesting that the company will succeed in efforts to reduce expenses to $13 per barrel of oil equivalent by the end of 2013.