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Take Oxy seriously

This week Occidental Petroleum (Oxy) entered into an agreement to purchase its DAC partner Carbon Engineering for $1.1 billion.


This is, by any accounting, a lot of money, as it is being spent well ahead of actual revenue related to Carbon Engineering's business. Oxy licensed Carbon Engineering's technology in May of 2019, with plans to use it to build a 500,000 ton/yr capture plant. Construction was "expected to begin in 2021, with the plant becoming operational within approximately two years." Fast forward to 2022 and Oxy announced the "first stage of construction, which includes site preparation and road work, is scheduled to begin in the third quarter of 2022 and start-up is expected in late 2024." In March, it postponed the project further to mid-2025, though it maintained its plans to invest between $200 and $600M during the year on its 'low carbon ventures', with the range dependent on potential funding from partners.


This slow pace and missed deadlines gave pause to those who were not inclined to believe that Oxy wasn't actually serious about carbon capture. Sure, Oxy's plans were big by the scale of direct air capture (DAC). But they were small on the scale of Oxy, an oil company that makes in the area of $20 billion per year in profit.


Then, the week before last, it found its funding partner. The Department of Energy agreed to subsidize Oxy with up to $500M for its DAC projects. With this government funding secured, Oxy turned around and immediately signed a deal to own Carbon Engineering outright. While the details of that transaction are private, it's reasonable to speculate that Oxy had bought a first right of refusal on the technology as part of its initial agreements. The value of a technology can be seen as its risk, multiplied by its reward, and with DOE funding the risk dropped significantly, so Oxy called in its option. Even though it was pricey.


What is motivating Oxy to pay so richly for a technology that has not even been tested at scale? The big prize is the California oil market, where the state offers $200/ton subsidies for direct air capture CO2 that is used in enhanced oil recovery as part of its Low Carbon Fuel Standard. On top of this, the US Inflation Reduction Act will chip in another $130/ton, for a stacked value of $330/ton. Oxy evidently is confident that it can capture CO2 for less than this, and it is throwing all its chips on the table. For what it's worth, the California oil market consumes about 37 million tons of oil per year today. Oxy's ambitions may be larger than this - they have publicly stated a goal to build 100 plants by 2035 - but California and its money provide Oxy a market that is large, secure, and potentially profitable enough to justify this large early outlay.


Some quick math: Let's assume that Oxy can make a $50/ton profit on these credits, and do so at a scale of 20 million tons/yr by 2035. These plants would be throwing off cash at the rate of about $1 billion/yr at that point. That cash happens far in the future, and it could be reinvested (or returned to shareholders) instead today, so that billion/yr is probably only worth $250M/yr in today's money. Still, it's worth it to pay $1.1 billion for that kind of cash flow. If you believe Oxy's ambitions for both the future cost and sale of DAC, the purchase makes sense.


Even at this scale, the transaction requires assumptions of a large amount of risk by Oxy and its shareholders - there is a chance that the winds of politics and tax credits could change, or that the engineering is harder than expected. But of course there are potentially larger risks of inaction. When considered as an investment in Oxy's ability to survive into the future, a $1.1 billion investment is a relatively small hedge to support a machine that is throwing off tens of billions of dollars in returns per year.


If nothing else, the investment confirms that Oxy really does have fire in the belly when it comes to DAC. Whether this pays off remains to be seen, but this certainly is a wake up call to the rest of the world that the oil industry now believes in a net zero future. Expect other companies to fall in line, and investment in DAC to rise in concert.


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