HOUSTON (Reuters) - Occidental Petroleum Corp’s surprise purchase of Citigroup’s Phibro business offers the potential for a significant boost in earnings but will test the conservative company’s appetite for risk as it enters the volatile world of oil trading.
Occidental said on Friday it would pay about $250 million for Phibro, its net asset value, bringing star trader Andrew Hall to a company that has little exposure to the volatile world of energy derivatives.
“Oxy historically has not been an aggressive hedger or trader,” said oil analyst Ben Dell at Sanford Bernstein.
“It has no history of managing a business in oil trading, and I think it will be challenging to argue that Phibro adds incremental value.”
Oil giants BP Plc, Royal Dutch Shell and Chevron Corp have long played in the speculative trading markets. Financial players such as Goldman Sachs, Morgan Stanley and Barclays are also among the biggest energy and commodities traders, often taking major positions in futures and over-the-counter markets.
Occidental has long touted its absence from the energy trading markets as a virtue, instead highlighting to investors its growing base of oil and gas reserves in low cost areas.
At the end of June, it had only three percent of its oil production hedged, and had a net derivative liability of just $238 million, according to Fitch Ratings, which warned the Phibro buy could erode confidence in the company.
“While trading operations are likely to generate significant income, they also have the potential to weaken the company’s future credit quality,” Fitch said in a statement.
For that reason, Phibro, which has averaged $371 million in pre-tax earnings over the past five years, may find it has less of a free-rein under Occidental than it did as part of Citi.
“They are not going to allow their hard work to be put at risk to let Phibro play a high stakes poker game. There is a new cop on the beat here,” said Fadel Gheit, energy analyst at Oppenheimer & Co.
EARNINGS BOOST LIKELY
Oxy obtained Phibro for a relative pittance because Citi, which has received tens of billions of dollars in government support, was anxious to quell criticism over the $100 million pay package Hall was to receive this year. That had put the bank squarely in the sights of “pay czar” Kenneth Feinberg.
Still, Oxy will have to move carefully to avoid driving Phibro traders off to other companies.
Most oil companies have trading arms, and some are involved in speculation, but the main function often is buying physical crude for refining or selling oil and gas production.
“These companies don’t typically throw a lot of capital into what they deem is a risky or zero-sum business, which is what trading is,” said Ken Medlock, an energy expert at the Baker Institute at Rice University in Houston.
“I think they’re going to be more interested in managing assets.”
Based on Phibro’s recent earnings performance, Oxy could see a 10-15 percent earnings increase, and potentially have its investment paid back in less than two years, Gheit said.
Those type of returns are attracting financial players, especially European banks, to commodity derivatives.
“Entry and exit in the commodity markets sector tends to be more cyclical than in other segments of finance,” said Craig Pirrong, director of the Global Energy Management Institute at the University of Houston.
“Right now, we’re in the entry phase of the cycle.”
Additional reporting by Joshua Schneyer and Matt Daily in New York
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