This Oil Stock Is Making a Killing on the Permian Basin Pipeline Shortage

Drillers in the Permian Basin have unleashed such a torrent of new oil production that it’s about to overwhelm the region’s pipeline infrastructure. According to an estimate by leading Permian driller Pioneer Natural Resources (NYSE: PXD), producers will fill pipelines to the brim in as little as four months. Because of that, the industry is leaving a record number of newly drilled wells unfinished, while some oil companies are starting to slow their drilling plans. Meanwhile, producers without guaranteed space on pipelines via contract might soon have no choice but to start shutting off wells, said Pioneer’s chairman, Scott Sheffield.

While that’s bad news for some companies, it’s a boon to others. One of the beneficiaries of the Permian pipeline shortage is Occidental Petroleum (NYSE: OXY), which has twice as much space as it needs. As a result, the company has been able to reap a windfall by using that excess capacity to its advantage.

Image source: Getty Images.

Sometimes it pays to be late to the party

Occidental Petroleum is different from most oil companies operating in the Permian. While many drillers are new to the area after snapping up land in recent years, Occidental Petroleum has a long history in the basin. However, a large portion of its production comes from legacy fields where it uses enhanced oil recovery (EOR) techniques such as injecting carbon dioxide into the reservoir to improve the flow of oil. That’s because the company has only recently begun tapping into the shale resources sitting underneath its acreage position.

One of the benefits of its background as a more conventional oil producer is that Occidental Petroleum has extensive logistics capabilities, including owning oil pipelines and other midstream assets to ensure the flow of its oil so it can maximize the value of every barrel. This approach has built-in redundancies to guarantee flexibility. Consequently, the company currently controls enough pipeline capacity to ship 470,000 barrels of crude per day to the Gulf Coast as well as having additional capability to send crude to the Mid-Continent region via a wholly owned pipeline, giving it more than double the pipeline space it needs to move its oil. That has proven to be a significant competitive advantage because the company not only doesn’t have to worry about its market access, but it can take advantage of the current pipeline crunch.

According to a report by Bloomberg, Occidental Petroleum is selling some of this excess space to other oil shippers while also buying crude from producers at a discount to sell it at higher prices in coastal markets. These sales have already net the company a $350 million windfall according to Bloomberg. With the capacity issues only expected to get worse until new pipelines start up in the second half of next year, Occidental Petroleum could continue cashing in on the current crisis.

Image source: Getty Images.

Winning in both the near and long term

This windfall is coming at an interesting time for Occidental Petroleum. Its aim this year has been to achieve its breakeven plan, which would see the company improve its underlying operations so that it could sustain its current dividend and production rate on $40 oil. That would enable it to grow output at a 5% to 8% annual rate at $50 crude. Thanks to its strong operational performance in recent quarters, the company is on track to complete its breakeven plan by the third quarter of this year.

However, with oil prices now over $70 a barrel and Occidental’s midstream business cashing in on the pipeline issues in the Permian, the company is on pace to generate significant excess cash flow in the coming quarters. Because of that, Occidental Petroleum plans to start returning more money to investors above its 3.7%-yielding dividend by restarting its share buyback program. It still has 64 million shares remaining under an existing authorization (representing 8% of its outstanding stock), which is ample firepower to buy back shares opportunistically. In the meantime, if oil prices tumble, it would still be in the position to thrive since it could maintain its dividend and grow the business at a much lower price point.

A unique way to play the Permian

Shale drillers in the Permian have been growing so fast that they’re about to overwhelm the region’s infrastructure, which could force them to slam the brakes. Occidental Petroleum, on the other hand, has taken a more methodical approach and now stands to benefit from their aggressiveness in the near term while still being able to execute its long-term plan. That ability to win now and in the future makes it a lower-risk, high-upside Permian oil stock for investors to consider.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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