When Occidental Petroleum (NYSE:OXY) made its big bet on buying Anadarko Petroleum, critics said the company paid too much. In fact, the company got in a much criticized bidding war for Anadarko. Occidental ultimately made the $38 billion purchase by selling $10 billion of preferred stock to Warren Buffett. That’s a deal that’s working out well for Buffett. But not so much for investors in OXY stock.
OXY stock is falling off a cliff and it’s not hard to see why. On March 9, the price of oil dropped nearly 30% before the markets opened and Occidental’s short-term fate was sealed. The company cut its quarterly dividend over 80% (from 79 cents to just 11 cents). OXY also announced that it would be cutting its capital spending by 32%.
“Due to the sharp decline in global commodity prices, we are taking actions that will strengthen our balance sheet and continue to reduce debt,” said Occidental Petroleum CEO Vicki Hollub.
Buffett’s preferred stock is unaffected by the dividend cut. But for other investors, this is a tough pill to swallow, particularly as the company’s share price is down 80% in the last 12 months, the bulk of that happening since the beginning of 2020.
Will the Current Price War Be the End of Shale?
Hollub says she is optimistic that Occidental could break even if U.S. benchmark oil prices fall into the low $30s. That supposition will be tested in a big way.
In general, oil drilling and exploration requires oil to be selling at a high price per barrel. That’s even more the case when it comes to shale, which is an expensive way to extract oil. In 2016, a wave of shale-reliant companies entered bankruptcy as oil prices dropped.
Some analysts are saying we could be seeing a repeat of 2016 now. Many shale companies were struggling to achieve profitability before the coronavirus outbreak torpedoed short-term demand for oil. A company with a high debt level such as Occidental is more likely to be affected.
However, Gabriel Dauod of Cowen cited that, in 2016, capital markets stepped in to help recapitalize many energy companies. That is not the case right now.
“We think effectively, the equity markets and even the debt markets are closed,” said Dauod. “If oil prices were to persist in this $35 to $40 barrel range over the next couple of years, you could certainly see a wave a bankruptcies accelerate, and you could certainly see more than what we saw in 2016.”
Short-Term Demand for Oil Will Be Weak
When interviewed about his confidence in his investment in OXY stock, Buffett said that a bet on Occidental is a bet on oil. Remember that Buffett is the definition of a long-term investor. However, Buffett acknowledges that the math is not in OXY’s favor.
“I don’t think the secular demand will change that much,” he said, as people fly and drive less during the coronavirus outbreak. “But certainly the immediate demand has changed.”
The Bottom Line on OXY Stock
The company may have managed to save itself from insolvency. But it’s hard to see where the growth will come from. The gamble on Anadarko was a bet on shale. And that bet was going to be risky, even if oil had stayed in the $50 range. At $30 a barrel, the growth prospects for OXY seem grim.
And make no mistake about it, oil prices will not be climbing anytime soon. As more and more public events are suspended in the United States, the price of oil will be dropping further. And while that’s good news for the few consumers who will still be on the road, it’s not so good for companies like Occidental.
Chris Markoch is a freelance financial copywriter who has been covering the market for over five years. He has been writing for InvestorPlace since 2019. As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.