California Resources (CRC) was in a very untenable situation at the start of its existence as a spin-off from Occidental Petroleum (OXY). The company started with leverage as if oil would stay at $90 WTI and above for a long time. When it lasted about a year until the big price crash in 2015, the company struggled mightily until the challenges of fiscal 2020 finally forced a reorganization. The new emerging company is in a much better situation than its predecessor. So now, finally, after all these years, there is a possible investment strategy that involves this stock.
This company remains a high-cost producer. So there is no way for the company to fund decent sized debt. Margins are good in the current operating environment. But these margins can easily disappear (or nearly disappear) during cyclical downturns in this industry. Therefore, the business needs to make a decent profit during the good times and then hang on as best it can when those inevitable downturns occur.
Coming out of bankruptcy with a low level of debt seems to allow such a strategy in the future. This management will probably never burden the company with debt in the future, because the last years will be very difficult to forget. No one would be eager to repeat this experience of the last few years. Mr Market will be waiting for evidence that the company’s management will not pursue a “debt satisfaction” strategy. But that evidence should soon become evident.
Business overhead is probably the only cost that needs to come down now that the major struggles are over. California is an expensive place to do business. But it probably doesn’t have to be as expensive as the slide above shows. Thus, a future reduction in general and administrative costs is in order.
The company has a pretty good operating record in some pretty sensitive areas. Returns are excellent while keeping first page “accidents” to a very low number. In fact, this company usually stays out of the news in a highly environmentally sensitive environment. The management is doing extremely well considering that the company operates in California.
California actually imports oil, so the prices the company gets are quite high compared to much of North America. This will likely remain the case for the foreseeable future as the state leaps into the renewable energy future before it knows exactly what it takes to get there. Now, if the state ever engineered a smooth transition using common sense that would allow the rest of us to keep the light on, then it would become apparent that oil and gas will be needed for quite a while. As someone who’s been through more than enough brownouts, the common sense part needs a little work. More than likely, most of us will go without heating or air conditioning, as shortages prevail while oil and gas are still needed for a longer period of time.
Debt issues and demands followed by bankruptcy caused maintenance to be postponed. Now that there is a good amount of cash, this business can finally catch up on things that should have been taken care of a while ago.
It is likely that production will increase simply by performing maintenance that the company did not have money for before. Current high commodity prices will give this company additional cash to plan for some growth.
For a long time, the company had a significant price advantage over much of North America. But as the chart above shows, that price advantage is waning. Thus, the focus should be on innovative cost reduction in the future.
Now, this company is in many ways a specialist in what it does. But many parts of the industry have introduced all sorts of improvements to reduce costs. This company didn’t really have the money or the flexibility to try nearly as much as its financially sounder brethren. This is about to change for the better in the future. The result should be a decline from the current level of processing costs per barrel over the next few years.
Probably the most unexpected increase in cash flow came from surprisingly high natural gas prices. This company had an emissions advantage because it mainly produced oil. Now that natural gas production has gained in value, there will be an added incentive to reduce the small amount of atmospheric leakage that existed to begin with.
This company has the opportunity to make yet another profit from the leased fields. California pushed very hard for the production of electricity by solar energy, convinced that such production would reduce pollution. The state’s renewable energy goals and the company’s portfolio benefit from this idea.
Plus, it can’t hurt to get very visibly involved in the green revolution when the company’s core business is oil and gas. Speaking of natural gas, natural gas seems to be the main source of hydrogen for the growing hydrogen market. Thus, this company is ideally placed to participate fully in the green revolution (much more so than a large part of the industry).
California Resources emerged from bankruptcy in very good shape. The company is still a high-cost producer. But debt levels are now appropriate for this high-cost production. As a result, management will be able to catch up on deferred maintenance and start innovating to reduce future operating costs, like the rest of the industry.
The only real costs that seem irrelevant are administrative costs. But these costs are now easily borne now that the company has emerged from bankruptcy. California probably has more “red tape” than the rest of the United States. But this administrative cost, even in this context, still seems quite generous for the company.
Basically, the company is now free to expand production and hopefully acquire out-of-state businesses that would provide low-cost growth. Management has positioned the company very well to participate in the green revolution. This should only improve over time for even more visible participation.
This company generally receives higher prices than the rest of North America. This advantage should continue in the future, but at a reduced level.
Ultimately, the business is much less risky than it was before the bankruptcy. There is an unusually experienced management team for the size of the company that remained after the Occidental Petroleum spin-off.
Most likely, the company will begin with a bankruptcy discount in the eyes of the market. But the valuation should improve over time as it is very unlikely that management will ever approach the leverage ratios of the past. On the contrary, this management is very likely to keep the debt at a very low minimum. This management will not need a reminder of the risks of high indebtedness after the experience of management since the spin-off.
So, for investors, there will be better valuation going forward (most likely). But a brighter future would be if the company purchased a refinery or expanded production outside the state of California. But no matter what management does, there is a decent future ahead of us for the first time.