OCCIDENTAL GET IT RIGHT?

It now seems that the massive Hedge undertaken by Occidental Petroleum Corp (OXY.N) and reported as “costless”

to its investors at the time back in July is anything but and does not provide adequate downside protection for 2021. At the time Occidental’s priorities were to provide reassurance to apprehensive investors, many who opposed the Anadarko acquisition that their share dividend was secure in its wake.

The company strategy was to execute a prompt and discrete hedge as possible, at little or no cost to the business.

Subsequent to the event  CFO Cedric Burgher said on an earnings call in August, “With the additional leverage from the Anadarko acquisition, these new hedges will strengthen our 2020 cash flow in a low oil price environment, and provide additional assurance that our dividend is safe, while we are deleveraging,”

It has however emerged through information published by Reuters that Occidental’s hedge exposes the company to a  potentially larger hit to future revenues and provides limited protection against falling oil prices.

According to Reuters, whilst Occidental fulfilled its regulatory obligations by  disclosing  the financial details of the hedge in their filings, the fact that the company took on the additional risk to secure a quick transaction in an attempt to avoid banker fees has  not been previously disclosed.

The hedge was arranged by Bank of America Merrill Lynch (BAC.N) and Citigroup (C.N), according to Reuters sources. The hedge covered nearly 110 million barrels of oil, or 300,000 barrels a day, each for 2020 and 2021.

The hedge meant Occidental Petroleum Corp could sell the oil at a minimum of $55 a barrel in 2020, even if crude prices fell below that, to a limit of $45 a barrel; but the company's selling price was capped at $74.09, and it would forfeit any revenue earned from oil rising beyond that price.

The hedge effectively capped Occidental revenues for 2020 and also 2021 but only provided downside protection for 2020 - a cockeyed deal sometimes referred to as a naked hedge.  That’s because it Limits  future receivables and offers no protection against the possibility  of  oil  prices  falling.

Some analysts said investors should have been given more information about the potential implications of the hedge. David Katz, president and CIO of Matrix Asset Advisors remarked, “It seems very strange that they left a naked hedge in 2021 which capped upside but offered no downside protection,"

Occidental insists  it does not regularly hedge its oil sales because it does not want to give up potential revenue. The last time the company hedged was in 2005, also following an acquisition. In the summer of 2019, Occidental was under pressure to demonstrate that its dividend was being protected.

Acting for Occidental's , Bank of America Merrill Lynch and Citigroup sold Put and Call option contracts, aiming to use the proceeds to finance the acquisition of a put option locking in Occidental's oil revenues at $55 a barrel for 2020.

However attempting to execute such a big transaction  In illiquid private markets, can be difficult, and therefore costlier. In the case of Occidental's hedge, the banks were unable to raise sufficient  money from selling the  Put and Call Option contracts for 2020 alone to cover the cost of the hedge. It is understood that consequently to remedy the situation the banks sold $74.09 call options for 2021 limiting revenue for said year.

There are Analysts that believe that it was important and the right thing for Occidental to do, pointing out not taking any action and hoping that oil prices hold up is simply not an option

It does not help if as Occidental Petroleum Corp,  has been under the trauma of a   haemorrhaging share price which has lost about a 1/3^rd of its value since the Anadarko acquisition. There is disgruntlement as many shareholders who were not allowed to vote did not like the deal. The CEO and Board have come under severe pressure from the likes of Carl Icahn is challenging Occidental's management for control of the board of directors.