Occasional Paper Series (No.

11) The Martindale Center for the Study of Private Enterprise College of Business and Economics Lehigh University Robert Thornton and Sharon P. Bernstein, editors July 2009

THE

STORY:

FROM THE BRINK TO EXCELLENCE

An Address Presented by Rodolfo Segovia Scholar-in-Residence

November 19, 2008

This is the text of the public address given by Rodolfo Segovia at Lehigh University on November 19, 2008. The address was given while Mr. Segovia, an Honorary Fellow of the Martindale Center for the Study of Private Enterprise, visited the campus as a Scholar-in-Residence.

A native and resident of Colombia, he was president of the national oil company and Minister of Public Works and Transportation. He has served on the board of Occidental Petroleum Corporation since 1994. In addition, Mr. Segovia serves on the board and the executive committee of Sanford Investments International, a private diversified conglomerate.

FOREWORD

Business strategy is a central business school academic topic. Scholarly reputations have been built on learned treatises, and the accounts of personal experiences by captains of industry sell countless books. Creating a credible business strategy takes acumen. Following it through requires perseverance, flexibility and discipline. Occidental Petroleum Corporation is a remarkable case study of the genre.

CHANGING OF THE GUARD

At the end of 1990, upon the death of Dr. Armand Hammer, who had led Occidental Petroleum Corporation (Oxy) since 1957, the companys Board designated Dr. Ray Irani as chairman and chief executive officer. Dr. Irani, Lebanese-born and a graduate of the American University of Beirut, received his PhD in Chemistry from the University of Southern California. He had been president and chief operating officer since 1984, and heir apparent since early 1990. With the Gulf War looming, oil, at $39 per barrel, had reached its highest price since the Iran-Iraq conflict ten years before. It would bring Occidental very moderate solace: only 17% of the Companys total business mix came from hydrocarbons. Almost half of its income derived from agribusiness (Iowa Beef and Processing [IBP], agrochemicals, fertilizers). Moreover, it was still recovering from the disastrous 1988 gas leak explosion in its offshore North Sea Piper platform, where 167 workmen (out of 223) had lost their lives, the worst such catastrophe in the oil industry.

Oxys core financials were unexciting. There were many unhappy stockholders and a class action lawsuit pending. Shares traded at $9 on an after-split basis (Oxy split 2 to 1 in 2006). Its very viability was questionable. In fact, it had to come back from the brink.

A STRATEGY Dr. Ray Irani laid down his strategy to reposition the company during the Annual Stockholders Meeting (May 1991). He announced that henceforth Oxy would focus on oil, gas and chemicals. Hurdles were many. There would be considerable tactical zigzagging instead of a straight line to get to the stated goal. Many regroupings of assets and operating refinements were not thought out from day one. Business strategy never seems to come in a neat package, and particularly not on the road to excellence.

The first task, before developing the proposed strategy, was to survive, which meant paring an asphyxiating debt and an unsustainable dividend commitment. It was slashed from $1.25 to $0.50, and during 1991 the company sold its interests in: Iowa Beef and Processing (IBP) The North Sea Piper oilfield The Corpus Christi chemical facility.

It also liquidated scattered oil and natural gas liquids properties and its involvement in ventures such as cattle and horse breeding, seed development, land and hotel development, film production, Russian petrochemicals (Tengiz) and a China coal mine. Divestitures totaled $ 2.7 billion Sales shrank from $21 to $10 billion Total employees went from 55,000 to 25,000 Total debt was reduced from $8 to $5 billion.

In the process, Oxy took a $ 1.7 billion restructuring charge, but by the end of 1991 it had become more focused. 2

Downsizing continued during the following years. Oxy sold additional oil and gas properties for $700 million and a $240 million block of Canadian Oxy shares. Other notable divestures were Trident NGL and MidCons (a gas transmission subsidiary) Border Pipeline. There were some acquisitions, not all on them with permanent impact, such as Monsantos agrochemicals business, which in the long run would not become part of a reappraised chemical mix.

The net result of the initial push was a more presentable, though hardly model, balance sheet, with an over 60% debt-to-capitalization ratio and poor EBITDA coverage. In essence the debt reduction strategy was hampered by the inability of the existing assets to generate enough cash. However, wheeling and dealing in search of better yields became part of the Oxy culture. Since 1990, not counting the initial and rapid downsizing, there have been years of more than forty big and small asset transactions.

TOWARD AN OIL PROFILE Oil and gas drew 70% of capital allocations to a worldwide carry-over portfolio of properties and to scattered new opportunities which led to: Commercial oil and gas discoveries in Ecuador (1991) Acquisition of a block in Yemen (1991) Active exploration and development program in the giant Hugoton, Kansas, gas area (1992) A joint venture with Vanyoganneft in Russia (1992 ) Large gas discoveries (non-operating partnerships) in Malaysia and the Philippines (1992). There was increased international exploration (Albania, Argentina, Bangladesh, China, Congo, Gabon, Hungary, Malaysia, Oman, Pakistan, Syria, Yemen) but Oxy was unable to replicate with the drill bit the billion barrel fields successes it had had in Libya (1966) or in Colombia (1983). Reserve replacements from exploration were disappointing.

Occidental Petroleum Corporation

1995 Worldwide Oil & Gas Exploration & Production

Ireland Netherlands California Permian Basin Mid-Continent Gulf of Mexico Venezuela Colombia Ecuador Peru

Russia (Vanyoganeft) Hungary Albania Pakistan Qatar Oman Yemen Malaysia

China (Bohai Bay) Bangladesh Phillipines

Gabon Angola

Congo Indonesia Papua New Guinea

Argentina

In 1994 Oxy made its first significant domestic oil reserves purchase. It acquired $250 million worth of proven US reserves at an advantageous price from bankrupt Placid Oil Company (in receivership). The purchase set the pattern for oil in the ground acquisitions. At about the same time, parlaying good Middle East contacts, Oxy made an agreement with the Qatar National Petroleum Company to increase oil production and recoverable reserves in the offshore Persian Gulf Idd-El-Shargi North Dome (SND).

The Qatar deal turned out to be a decisive move for the future of Oxy. The oil in the contracted field had already been discovered. The trick was to apply enhanced oil recovery techniques (EOR) to improve yields. The company had experience in the North Sea and onshore in the United States. A similar onshore contract was signed in Venezuela. EOR would henceforth become a core competency of Oxys oil expansion strategy. The eventual success in increasing reserves and production in offshore Qatar contributed significantly to building Oxys credibility in the Middle East.

THE CHEMICAL PATH Oxy Chemicals had already begun to emphasize chlorine, caustic soda and vinyl before 1990. These constituted products where it enjoyed economies of scale, strong demand and high utilization rates. In fact, the fundamental consolidation steps to become an integrated player in the vinyl chain, from salt and electricity to chlorine, caustic and PVC, had been taken in the 1980s. Now the emphasis continued as part of a narrowing strategy. Oxy would concentrate in these basic chemicals where it was one of the largest producers in the world, with cheap feed stocks in the Gulf Coast (gas at $1.50/mcf) at the time, and marketing flexibility. As it redefined its chemical product profile, Oxy sold its: Agricultural chemical businesses Phosphates and fertilizers High density polyethylene (HDPE) facilities.

SHARE PRICES Divestures emphasized the effort to exit from non-core businesses while at the same time trying to maintain debt at a manageable level. This was difficult to attain. Debt-to-totalcapitalization ratios for the period would stay in the 65 to 70% range. Nevertheless, in 1996 Moody modestly improved Oxys credit rating from Baa3 to Baa2 to reflect Oxys progress in strengthening its balance sheet and the prospect of stronger earnings It had still a way to go. 5

High debt and the still heavy emphasis on chemicals affected Oxy shares performance. After five years of asset shifts, Oxy in 1995 was correctly viewed as a chemical company, subject to punishing market cycles and with moderate growth potential. The price-to-cash-flow ratio of its shares was below that of better defined and positioned oil companies. Share value stagnated around $12 to $14.

CHEMICAL CREATIVITY One route towards differentiation was to acquire a position in specialty chemicals. It already manufactured phenol resins, silicates and chromates. Lacking a strong research tradition to develop new products, Oxy began to buy companies to add to its product line. The path turned out to be a dead end, and it was eventually abandoned.

A more assertive shift was called for. In 1998, Oxy merged its petrochemicals (ethylene, ethylene derivatives and propylene) into a non-operated joint assets venture. It ended with a 26.5% ownership in Equistar, which became the largest ethylene producer in North America, and its cash flow. Synergies brought net costs savings, improved returns and $625 million in immediate cash to Oxy. About the same time, stressing the vinyl chain, it contributed its polyvinyl facilities to Oxy Vinyl LP, another joint assets venture 6

of which Oxy owned 76%. The alliance resulted in the second largest PVC manufacturer in the US. The chemical segment alliances aimed at creating very large units with market share leadership (No. 1 or No. 2) in order to achieve a highly competitive cost structure for improved return on assets (ROA).

The asset mergers strengthened cash flow and brought modest share appreciation but it was still evident that as long as chemical sales represented over half of the companys gross numbers the investment community remained unimpressed.

Meanwhile, Oxy stock ownership mix had been changing. Instead of individual shareholders swayed by dividend payments held constant under the weight of debt obligations institutional investors comprised an increasingly greater percentage of the stock. Their preference was for growth as a price driver of the shares. The trend reinforced a management aim: total return to shareholders. As we will be seeing, the company only began to raise dividends after debt to total capitalization ratios improved.

Occidental Petroleum Corporation

Percent of Shares Held by Institutions and Retail Investors
90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 1992 1995 2000 2005 2008 Percent Held by Institutional Investors Percent Held by Retail Investors

Occidental Petroleum Corporation Historical Annual Common Dividends*

$1.30 $1.20 $1.10 $1.00 $0.90 $0.80 $0.70 $0.60 $0.50 $0.40 $0.30 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.50 $0.52 $0.55 $0.65 $0.80 $0.94 $1.25 $1.21

* Split adjusted

AN OIL OPPORTUNITY Although still heavily indebted, it appeared to management that a big push into oil could modify how the market viewed Oxy. The patiently awaited opportunity arose when in 1997 the huge Elk Hills Naval Petroleum reserve in California became available. Oxy sold its MidCon natural gas storage and transportation subsidiary for $3.6 billion (plus several other assets) to bid toward the purchase of 78% of the reserve for $3.5 billion. It was a gamble. In 1998 oil reached, at $10 per barrel, its lowest quotation (unadjusted for inflation) since the 1973 Oil Shock.

There was no debt reduction, but Oxy gained possession of a large critical mass field with upside prospects. The MidCon transaction shifted one third of Oxys assets and 45% of its profits in 1996 from a pipeline business threatened (to its eventual demise) by the flow of Canadian gas toward a different risk in oil and gas with greater earnings potential. Elk Hills, close to Oxys legacy petroleum properties near Bakersfield, offered opportunities to use economies of scale to achieve major cost reductions. The acquisition rounded the strategic concept of large assets management implicit in the chemical concentration stride.

The Elk Hills purchase went together with the decision to shrink geographical dispersion of oil properties around the world in order to concentrate large assets in a few regions. With limited resources Oxy could not afford to be in everything, everywhere. It had to limit its reach. The purpose was to reduce overhead by acquiring large and long-lived assets with the potential to receive property add-ons with minimal extra administration expense. In the process Oxy sold or swapped: Oil EOR in Venezuela Oil and gas in Bangladesh, Peru and Argentina Gas in the Netherlands Gas reserves in Malaysia and the Philippines to Shell in exchange for oil producing participations and blocks in Colombia and Yemen. Properties in East Texas and Oklahoma (EOG) for California production and Gulf of Mexico acreage. In the Shell asset swap, Oxy sacrificed probable reserves for actual production of 46,000 barrels of oil equivalent per day (boed). Moreover, the disposed of properties liberated it from capital requirements of $1.8 billion for the long-term development of some of those reserves.

Balance sheet limitations meant also that Oxy would remain an exploration and production (E & P) company. There was no effort to extend the business downstream.

RIGHTSIZING As it moved further into oil while reducing complexity, Oxy adjusted as best it could for the 1998 oil price lows. It tidied up by shedding: One third of its business segments One half of its U.S. oil and gas properties One half of its foreign oil and gas operations One third of the chemical assets managed directly by Oxy

all of which translated into: Closing U.S. and foreign offices Consolidating and streamlining support functions Outsourcing at reduced costs its non-core functions and implementing best practices throughout the company Applying technology solutions to enhance efficiencies and reduce costs.

Rightsizing resulted in headquarters staff reductions of 50% in Oil and Gas, 20% in Chemicals and 45% in Corporate, for an overall reduction of 25%.

1997 Worldwide Operations

Russia Ireland United States Netherlands Hungary Albania Pakistan China Qatar Venezuela Colombia Ecuador Peru Gabon Congo Angola Yemen Bangladesh Oman Malaysia Indonesia Papua New Guinea Philippines

Argentina

Producing Countries

10

2000 Worldwide Operations

Russia United States Qatar Yemen Colombia Ecuador Peru Oman Pakistan

Indonesia

Producing Countries

Since then, Oxy has kept its headcount at approximately the same level, below 10,000 employees, despite adding asset and production areas with a steady increase in the hydrocarbons produced per employee. The latest rightsizing push came in 2007-08.

Occidental Petroleum Corporation Worldwide Employees

60,000

50,000

40,000

30,000

20,000

10,000

0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

11

ROUNDING UP THE STRATEGY: MORE OIL AND GAS In 2000, true to its strategic commitment, Oxy completed a second significant step in the push toward large oil assets by acquiring Altura (from BP and Shell), a group of mature fields in the prolific Permian Basin in West Texas and New Mexico, where Oxy already had a modest position. Altura increased Oxys proved reserves-to-production ratio from 8.7 to 12.4 years, a major 43% increase in reserve life. At $3.6 billion, it was a huge commitment, for it was not a certainty that the price of oil (although recovering from its trough) was going to rebound quickly. In fact, it reached $30 per barrel around the time of the Altura purchase, but by the end of 2001 it had again dropped below $20.

With Altura
Reserves/Production Ratio
(Years) 12.4

9.1

8.9

8.7

1997

1998

1999

2000

In order to raise $2.35 billion toward financing the Altura purchase, Oxy sold in 20002001: Oil and gas properties in the Gulf of Mexico A 40% farm-in of its Ecuador fields Peru interests The remaining Canadian Oxy shares ($700 million) Durez Chemicals (phenol resins) Tangguh LNG participation in Indonesia ($500 million) Occidental Texas Pipeline Co. 12

Oxy also received $775 million from Chevron for the settlement of an outstanding claim. The Durez sale was in line with concentration in the vinyl chain. In 2003 Oxy found a purchaser for its chrome chemicals. With the acquisition of Altura, the tenets of the overall strategy came into sharper focus: Oxys main oil production would be US-based, with platforms in the Permian Basin and in the Central Valley of California. Since then (and almost annually) new fields have been attached to them or to their vicinity through swaps or outright purchase, notably the very profitable Thums acquisition in Long Beach, California (with adjacent Tideland bought in 2006). Oxy would carry out moderate risk exploration and EOR programs in these two core property centers, targeting large, high-quality, long-life reserves with economies of scale. Oxys mature US properties were intended as long-lived cash-flow-producing assets to be grown through consolidation. They have since steadily produced two thirds of its oil. Intensive water injection, infill drilling and advanced carbon dioxide (CO2) flood techniques, in which Oxy has become a world leader, have been employed to offset natural decline. The company took advantage of purchasing opportunities as they arose in order to reduce overhead costs and improve earnings quality. Moreover, step-out exploration and low-to-moderate-risk wildcats have replaced some of the depletion. The success of the strategy can be gauged by comparing its operating income per barrel with that of its peers.

13

Occidental Petroleum Corporation

1997 - OIL & GAS OPERATING INCOME*
($ /BOE)
6.48

4.41

4.30

4.12 3.73 3.63 3.25 3.15 3.13 3.06 2.98 2.83 1.96

XOM

APC

CVX

MRO

APA

OXY

UCL

COP

KMG

DVN

BR

BP

AHC

* Exploration and production income (per FAS 69 format) after taxes and before interest expense

Occidental Petroleum Corporation

2000 - OIL & GAS OPERATING INCOME*
($ /BOE)
11.38

8.92

8.78

8.76 7.50 7.44

7.18

7.04

6.81

6.34

6.24

6.17

2.58

OXY

APA

APC

KMG

CVX

BP

COP

XOM

DVN

AHC

UCL

BR

MRO

Exploration and production income (per FAS 69 format) after taxes and before interest expense

DECANTING THE STRATEGY As a business strategy Oxy would concentrate on large, cost-competitive assets in its oil, gas and chemicals core businesses. The company would only acquire properties that met these criteria unless they were absolute bargains. Assets that lacked potential to increase critical mass and competitive cost structures were gradually sold. 14

Core Assets
Income
Core Assets
California Permian Basin Hugoton Yemen Qatar Colombia

Other Assets
11%

89%

Repositioning could not have been possible without an unusual knack for acquisition and divestiture to create value. It bought patiently at attractive prices. Its oil and gas purchases compare favorably to the best finding and development costs in the oil industry. There was a demonstrated willingness to sell low-performing assets in order to upgrade asset mix and improve returns. The same flexibility was applied to chemical assets from which Oxy harvested cash flow to fund new oil and gas growth opportunities.

15

Occidental Petroleum Corporation Asset Sales

$3,500 $3,000 $2,500 $ Millions $2,000 $1,500 $1,000 $500 $0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Oil & Gas

Chemicals

Other

Occidental Petroleum Corporation Asset Acquisitions

$5,500 $5,000 $4,500 $4,000 $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

$ Millions

Oil & Gas

Chemicals

Other

Timing was outstanding. As Oxy rounded out its oil and gas strategy, the price of hydrocarbons began to climb, although, as mentioned above, not steadily. There were nervous moments. Part of it was foresight; but in developing a winning strategy good fortune is, of course, helpful. By 2000 Oxy had become primarily an oil company.

16

Occidental Petroleum Corporation Segment Sales

($ Millions)

1990
Coal $694 Oil & Gas $3,832 Natural Gas Transmission $2,049

1995
Oil & Gas $3,043

$10,187 $5,116 Chemicals $5,410 $2,322

2000
Chemicals
Chemicals $3,795

Agribusiness
Natural Gas Transmission

$9,779

Oil & Gas

RECOGNITION The business world took notice. Business Week ranked Oxy 21st in the list of 25 top performers, noting strong profit growth, return on equity and total return to shareholders. It came in second among the oil and gas companies. Fortune magazine also acknowledged Oxys transformation by listing it 50th in its roster of 100 FastestGrowing Companies. Recognition opened doors overseas.

OVERSEAS OIL OPPORTUNITIES With stable cash flow from US properties and a clear path for its development, Oxy searched for faster growth and higher return opportunities abroad without losing sight of the need for geographical framework and applying a strict code of business conduct. In its dealings overseas it would follow two basic tactical principles: willingness to support legitimate host government needs and openness to develop flexible partnerships with national oil companies. Also, Oxy drew on its US EOR expertise and on its store of foreign experience.

17

As stated before, Oxy recognized that it did not possess the breadth to be all things in all places. Geographical discipline was married to the large assets, low-overhead cost philosophy. It was imperative to decide where to concentrate and how to concentrate. Oxy preferred to be the operator wherever it was possible. It further divested in non-core parts of the world, and it swapped for properties not only to reduce debt but to bundle areas of interest. It had to choose carefully, knowing that opportunities to develop oil overseas were being increasingly curtailed.

Oxy built on its strengths in the Middle East and, for historical reasons, in Libya and Latin America. It concentrated activities around the prospective Saudi Arabia coastal rim and in Spanish America in countries where it already had contacts or a sizable presence. Only very opportunistically did it accept attractive deals elsewhere.

18

THE MIDDLE EAST The Middle East has the worlds largest oil reserves and the lowest cost producers. Extensive tracts are under-explored or under-exploited. It was a natural area of concentration. Alone and through its Canadian affiliate, Oxy had a significant presence in Yemen. It added exploration areas in neighboring Oman. In 1997 it complemented its above-mentioned Qatar venture with the close-by Idd-El-Shargi South Dome (SSD).

20,000

95,000

An attempt to make a deal with the Saudis did not come to fruition because the terms offered fell short of Oxys ROE discipline. It was, however, encouraging for Oxy as a measure of the distance traveled to become a well-recognized oil company to have been chosen to partner with super majors in the bid rounds.

In 2002 Oxy took a crucial step towards further involvement in the Middle East. It was selected by the United Arab Emirates Offset Group to hold a 24.5 % interest in the $3.5 billion Dolphin Project. The project entailed a 48-inch, 260-mile underwater gas pipeline across national borders between Qatar and the UAE and the development of North Field (Qatar) natural gas reserves to supply it with two billion cubic feet per day. After a oneround strongly-contested single bid, Oxy took over what had been Enrons interest. Dolphin was a visionary long-term major endeavor with a promise of 30 years of steady 19

cash flow and an extended view of the region. At the time it faced significant engineering and political issues.

In 2005 and on the strength of its EOR experience and relationships in the Middle East, Oxy entered an agreement to develop production in the giant Mukhaizna field in the Sultanate of Oman with a 45% working interest. This complex steam injection project is already ramping up oil flows which have trebled since its inception. They should increase to 150,000 barrels per day in the next few years. Abu Dhabis Mubadala Development Company (through Liwa Energy) is a 10% partner in the Oxy part of the investment.

NORTH AFRICA Reaffirming the strategic commitment to enter new areas only if it could concentrate in large assets, Oxy was the first American oil company to return to Libya after the 2004 lifting of US sanctions. In a move that had been carefully prepared through several years of contacts at the technical level with the blessing of the State Department, it recovered its legacy concession which by then produced only around 20,000 barrels of oil. Oxy had had huge historical success in Libya its great leap forward. A 1966 discovery topped

20

out at around 660,000 barrels a day in 1970. This property had been put on hold by the 1986 embargo.

Oxy participated next in the first Libyan licensing round, winning the majority (9) of the areas offered in advantageous conditions when considering those obtained by other players in later bid rounds. Liwa Energy is again a partner with 10% of the Oxy stake.

Although exploration success in Libya has been limited, the carefully nurtured relationships have resulted in Oxy signing an attractive net-of-tax 30-year contract for secondary recovery in the giant Nafoora Augila reservoir (over seven billion barrels of oil in place). The company paid $750 million in installments for the privilege of a 75% participation.

Middle East/North Africa Growth

2007 net production*
135 mboe/day 24% of worldwide total

Libya Qatar UAE Oman

2007 reserves*
468 million boe 16% of worldwide total
* See attached for GAAP reconciliation.

Yemen

LATIN AMERICA Oxy had been obtaining exceptional (close to 60%) recoveries in Colombias Cao Limon field in the Cravo Norte association contract with Ecopetrol, the national oil company. In 2004 it extended contract life of the holdings until the end their economic viability. In a separate transaction, it entered into an agreement to apply EOR techniques and significantly increase production in La Cira-Infantas, Colombias oldest giant 21

reservoir, which has been in continuous exploitation since 1926. It is performing above expectations.

RESOURCE NATIONALISM The oil business overseas is no bed of roses. Resource nationalism is a lurking hazard. After arduous years of exploration and EOR campaigns in the jungles of Ecuador, Oxy had built a significant production and reserve position and had contributed its share to building a new trans-Andean pipeline. The facilities were taken over by the government of Ecuador in 2006. Oxy expects compensation. It has appealed to the International Centre for Settlement of Investment Disputes (ICSID), invoking the protection of the USEcuador Bilateral Investment Treaty. Losses under discontinued operations were charged to the 2006 income statement.

Occidental Petroleum Corporation

2006 Worldwide Oil & Gas Exploration & Production

Russia (Vanyoganeft)

California Permian Basin

Mid-Continent Gulf of Mexico

Libya

Pakistan Qatar UAE Oman Yemen

Colombia Ecuador

Bolivia

Argentina

FINANCIAL AND OPERATIONAL DISCIPLINE Results improved, riding on rising oil prices, increased production and decanted asset quality. As opportunities deal flow became substantial, the internal bar of approval rose higher. New ventures had to compete with stringent return requirements and with the low risk alternative of share repurchases. Moreover, having lived for a decade with perilous

22

debt-to-total-capitalization ratios, Oxy aimed at improving its financial matrix. It intended to be prepared for the next oil price cycle.

Given the increase in petroleum prices, new projects had to meet stringent expectations to create long-term value and remain in the top quartile in financial performance. Returnon-capital-employed (ROCE) targets were set at: Domestic 15+% International 20+%.

Short of these goals, share repurchases were a cash-management option. Nevertheless, Oxy found programs that surpassed the bar; capital was deployed while at the same time improving debt-to-equity ratios dramatically.

On the operational end of the business, Oxy built on its experience in applied state-ofthe-art technology to increase the EOR success rate. This meant extensive use of three dimensional (3D) seismic for flow simulation and integrated reservoir characterization, horizontal drilling and slim hole technology, field automation and fracturing technology.

Occidental Petroleum Corporation Capital Expenditures & Average Oil Price

$4.0 $80

$3.5

$3.5 $3.0

$70

$3.0

$60

$2.5 $ Billions

$2.4

$50

$2.0

$1.8 $1.6 $1.5 $1.3 $1.1 $0.9 $0.6

$40

$1.5

$1.2 $1.0 $1.1 $0.9

$1.2 $1.0

$1.2

$1.2

$30

$1.0

$20

$0.5

$10

$0.0 1990 1991 1992 1993 1994 1995 1996 1997 1998 Capital Expenditures 1999 2000 2001 2002 2003 2004 2005 2006 2007 Average Oil Price

$0

23

Occidental Petroleum Corporation Capitalization

%
$25
$22.1

Total Debt / Total Capitalization

$24.6

$20
$18.1

$ Billions

$15
$12.4 $10.3 $9.3 $10.1 $10.7 $10.2 $9.9 $9.5 $9.3 $9.0 $12.9 $11.1 $10.5 $11.1 $12.5

$14.5

$10

$5

67
$0

58

63

66

71

68

62

67

66

61

71

57 46

43

37

27

17

13

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 Apr- 2000 2001 2002 2003 2004 2005 2006 2007 00

Debt

Equity

Meanwhile, the stock-price-to-cash-flow ratio improved as had been intended.

Occidental Petroleum Corporation Cash Flow from Operations before Interest and Taxes
$10
$9.2

$9 $8 $7
$7.4

$8.7

$ Billions

$6 $5 $4 $3 $2 $1 $0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

$5.0 $3.9 $3.5 $2.5 $1.6 $0.8

$3.6 $2.7 $2.3 $1.9 $1.3 $1.3 $1.4 $2.7 $2.0

24

Occidental Petroleum Corporation Peer Group - Price/Cash Flow

14 12 10 8 6 4 2 0 1990 Occidental Exxon 1995 Conoco 2000 Chevron 2005 Phillips 2008 Texaco Mobil

EXPANDING THE MODEL In 2006, having reduced debt-to-total-capitalization to 17%, Oxy expanded the model. Another chapter in the concentrating assets strategy brought in after long negotiations Exxonss West Texas Permian Basin properties at the cost of $1 billion. It confirmed Oxys position as the number one oil producer in Texas.

In 2005-2006 Oxy sold, at the height of the petrochemical boom, shares of Lyondell (obtained in exchange for its interest in the Equistar joint assets venture), and it also disposed of its 10% participation in Premcor refining (acquired in a favorable private placement in 2003). With these transactions it raised $1.4 billion. The liquidity, plus its now respectable balance sheet and cash flow, made possible the direct purchase of Vintage Oil for $4 billion in cash and common stock. The Vintage property fit was excellent. It reinforced positions in California, the Permian Basin and Yemen. Oxy also reentered Argentina by obtaining a large asset with upside potential (proven reserves on 177 million barrels at the end of 2007). Bolivian marginal gas production came with the mix. Within a year Oxy sold $1 billion in Vintage properties outside Oxys geographical scope.

25

Latin America Operations Growth

Colombia

2007 Net Production 76 mboe/day 13% of worldwide total

Bolivia

Argentina

2007 Reserves 244 million boe 9% of worldwide total

* See attached for GAAP reconciliation.

Also in 2006, Oxy obtained production fields close to its own facilities in California and West Texas from Plains Exploration and Production Company for $865 million. The new properties contributed 7,200 barrels per day with significant upsides. In 2008 at a price tag of $2.8 billion, it bought more Plains reserves and 27,000 boed production in Permian Basin and in Colorado.

The Colorado purchase, added to the Utah Wolverine properties staked in 2007, is of special interest; it signals Oxys intention to develop a Rocky Mountains tight gas business, in what could become a separate production assets province when the time is right.

26

US Oil & Gas Operations Stable Cash

Piceance Basin Elk Hills & California Properties Sheep Mountain Bakersfield Los Angeles Long Beach Bravo Dome Hugoton

Oxy Permian

Houston

2007 net production* 359 mboe/day

2007 reserves* 2.15 billion boe

63% of worldwide total

75% of worldwide total

* See attached for GAAP reconciliation.

In 2007, in a move toward concentrating holdings, Oxy sold isolated and lower-return properties in Russia and Pakistan, while purchasing Anadarkos Qatar interests and entering exploration in Bahrain.

Further asset concentration went together with continued best-in-class operating results.

27

Occidental Petroleum Corporation

2007 - OIL & GAS OPERATING INCOME*
($ /BOE)

21.30

17.00 15.28 14.91 14.51 14.46 13.02 12.53 12.41 11.96 9.53

OXY

XOM

APA

CVX

DVN

ECA

HES

BP

MRO

COP

APC

Exploration and production income (per FAS 69 format) after taxes and before interest expense

Production increased at the steady rate of 5.5 % per year though, true to its business strategy, volume growth was secondary to the earning quality of the barrels produced. This is especially critical in overseas oil where often higher prices bring better margins but a reduced share of the production volume.

*The production drop in 2007 stems from the sale of Russian and Pakistan holdings. Preliminary estimate for the 2008 average production is 601,000 boed. 28

On average, annual reserve replacement was 181% during the last decade, mostly through purchases, step-outs and better recovery. A limited amount came through moderate risk exploration discoveries.

Occidental Petroleum Corporation Reserves Replacement %

400% 378%

300% 257% 202% 138% 140% 145% 116% 216% 181% 119% 100% 100%

200%

0% 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 10 Yr. Avg.

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TWEAKING THE MODEL In 1998 Oxy reorganized its crude oil and gas trading to bring scattered pieces under one roof in Houston. All of them, including co-generation power offerings, were

consolidated to form a marketing and trading organization to add quarters and dimes to the margin realized on each barrel of oil.

To enhance the value of its position in the Permian Basin, Oxy contributed cash and swapped participation in producing Gulf of Mexico Horn Mountain for a network of BP pipelines in Texas (plus Permian Basin properties), the most important of which leads to Cushing, Oklahoma, the nerve center of oil marketing in the US. Having transportation and storage with control of large amounts of oil contributes to the net cash (netback) per barrel. Equally important in the BP deal was the acquisition of CO2 reservoirs for EOR in the Permian Basin. Insufficient and costly supply has held Oxy back from pursuing a more aggressive exploitation of reserves.

CHEMICAL CASH FLOW For the last eight years chemicals have fulfilled their role as a cash flow generator. Investments have concentrated on efficiency improvements or stay-in-business items, unless very attractive opportunities arose. Two profitable marginal acquisitions have not modified this overall chemical strategy: In 2005 Oxy purchased for a favorable $215 million price tag chlorine-caustic and chlorinated-solvents facilities that Vulcan Materials wished to divest. The acquisition allowed Oxy to further consolidate its chorine-caustic vocation, to phase out older plants and to accelerate the environmentally desirable and customer-pleasing transition away from mercury cell technology (a conversion that has been completed). In 2007 Oxy obtained for $250 million the remaining 24% of the PolyOne PVC joint venture. This reaffirmed its vinyl chain position as the number two producer in North America and rounded out the all important assured outlet for chlorine.

Chemicals have generated an annual average cash flow of approximately $500 million (net of capital spending) since 2000.

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Occidental Petroleum Corporation Chemicals Segment Sales

$5,500 $5,000 $4,500 $4,000 $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

$ Millions

Basic Chemicals

Vinyls

Specialty/Performance Products/INDSPEC

Petrochemicals

AG Products

Note: Does not include Eliminations and Other

Occidental Petroleum Corporation Segment Sales

($ Millions)
1990
Coal $694 $3,832 Oil & Gas Natural Gas Transmission $2,049 $3,043 $10,187 $5,116 $9,779 Chemicals Agribusiness $2,322 Natural Gas Transmission Chemicals $5,410 Oil & Gas Oil & Gas

1995

2000

Chemicals

$3,795

2005
Chemicals $4,641

2008E*

Chemicals

$5,306

$10,416 Oil & Gas $20,966 Oil & Gas

* Estimate based on six months actuals

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INSIDE OUT Oxys business strategy ran in parallel with a growing awareness of social responsibility. As part of a holistic approach to running the company it has translated, for instance, into the empowerment on safety issues down (including rewards for performance) to the lowest ranking employee, with oversight from a board of directors committee. Potential risk reduction and safety, linked as it is not only to strong financial performance but also to the very view that a company has of itself, have had priority over all other capital expenditures. It stems from the conviction that a secure working environment is the essence of good management. The incessant campaign, which built on efforts begun before 1990, has resulted in a safe environment where the injury and illness incidence rate has shown a continuous decline and is now among the lowest in the oil and gas industry. Safety emphasis encompasses Oxy contractors. Tracking statistics for them began in 1995. Results have been very encouraging.

Oxy Employee Safety

Performance vs. Industry Peers
4.0 3.5 Injury & Illness Incidence Rate 3.0 2.5 2.0 1.5 1.0 0.5 0.0 1990 1992 1994 1996 1998 2000 2002 2004 2006

API Total U.S. Employees

Oxy Worldwide Employees

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Ever-tightening environmental mandates and Oxys relentless discipline have also meant careful reduction of effluent releases at its chemical plants and oil and gas operations worldwide, as measured by emissions per equivalent barrel of oil and per ton of chemicals produced. It has been attained despite numerous acquisitions that take time to be brought up to Oxys demanding standards.

Legal requirements and social responsibility have led to Oxys extensive involvement in site remedial actions. Although originally a small oil company, Oxy grew to become a chemical player, mostly through acquisitions. It consolidated chemical assets from many sources including sites with a long and disturbing environmental past. One of them which received considerable public opinion exposure was Love Canal in upper New York State. Many sites had been tackled before 1991 as environmental legislation became more demanding. In 1993 Oxy established Glenn Spring Holdings, a wholly owned subsidiary solely in charge of tending the legacy sites for which Oxy is responsible. Several of them, totally restored, have come off the remedial list, notably Love Canal. Remediation is, of course, a long-term task. In the last 15 years Oxy has spent $1.35 billion on

environmental repairs. At present reserves for this purpose stand at $400 million.

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GOVERNANCE

In the early 90s, Oxy was a business school example of troubled corporate governance. As part of its overall approach to openness toward shareholders and public alike, a chapter on social responsibility, the company has taken steps that place it in the goodgovernance forefront, as has been recognized by monitoring entities. These have been the policies adopted:

Reduced size of board (1993) Adopted a confidential voting policy (1994) Adopted officer stock ownership guidelines (1995) Poison pill expired (1996) Stock added to director compensation (1996) Began phase-out of classified board (1997) Adopted code of business conduct (1997) Published corporate governance policies www.oxy.com (1999) Appointed lead independent director (1999) Governance materials added to proxy statement (2001) Adopted shareholder rights plan policy (2002)

34

Adopted human rights policy (2003) Adopted policy to limit golden parachutes (2005) Majority vote requirement for board members (2006) Began to consider say-on-pay (2008).

The board is now composed of eleven independent directors and one insider, while key committees (Audit, Executive Compensation and Human Resources, Corporate Governance and Social Responsibility, Environmental, Health and Safety) are entirely comprised of independent directors.

THE DISTANCE TRAVELED A short version of a seventeen-year business chronicle must necessarily choose what it highlights. Essential aspects may be lost in the details. All factual information comes from Oxys published annual reports or from presentations for business and investment groups. Before concluding, it may be useful to list the policies and steps in Oxys push to excellence since 1990: 35

Rightsizing An oil company Large assets Cost control Debt reduction Safety and governance Total return to shareholders.

These were the more significant steps: Rapid divesture of non-core assets Petrochemicals sales and consolidations Chorine-caustic-vinyl concentration Qatar Elk Hills Altura Dolphin Vintage.

The success of Oxys business strategy and implementation can be best captured through a few 1900-2007 summarizing graphs:

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The Oxy Transformation 1990-2007

Core Results
($ Millions) $5,000 $4,000 $3,000 $2,000
$1,361 $3,732 $4,405

$1,000
$191

$752

$0 1990 1995 2000 2005 2007

The Oxy Transformation 1990-2007

Debt Reduction Including Preferred Stock
($ Millions)
$8,070

$8,000
$6,941

$7,000 $6,000 $5,000 $4,000 $3,000

$6,356

$3,019 $1,813

$2,000 $1,000 1990 1995 2000 2005 2007

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The Oxy Transformation 1990-2007

Stockholders Equity
($ Millions) $25,000 $20,000
$15,091 $22,823

$15,000 $10,000
$4,112 $4,630 $4,774

$5,000 $0 1990 1995 2000 2005 2007

Occidental Petroleum Corporation Oxy Debt Ratings

S&P A Moodys A2

A-

A3

BBB+

Baa1

BBB

Baa2

BBB-

Baa3

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

S&P

Moody's

38

Occidental Petroleum Corporation

39

A PARTING THOUGHT

Beginning in 1990, Occidental Petroleum Corporation designed under the leadership of Dr. Ray Irani slowly, carefully and sometimes hesitatingly a business strategy that has been a success. For now, future challenges to its niche remain exactly that: future challenges. It seems fair to point out, however, that current trends in energy supply and consumption may be unsustainable environmentally, economically and socially. It seems also fair to assume that, judging from past performance, Oxy should be flexible enough to ride them. Its response may be well worth another business school paper on strategy.

40

MARTINDALE CENTER FOR THE STUDY OF PRIVATE ENTERPRISE CENTER STAFF

J. Richard Aronson Robert J. Thornton Judith A. McDonald Todd A. Watkins Robert Kuchta Director Associate Director Associate Director Associate Director Assistant Director of Marketing

Paul Brown Dean, College of Business & Economics The Martindale Center for the Study of Private Enterprise was established in 1980 with a gift from alumnus Harry Martindale and his wife Elizabeth Fairchild Martindale. Formed as an interdisciplinary resource in the College of Business and Economics, the Center contributes through scholarship to improved understanding of the American economic system.

MARTINDALE CENTER PUBLICATIONS

Periodicals
Perspectives on Business and Economics (Annual) Martindale Discussion Paper Series Occasional Paper Series

Books
I. Lieberman and D. Kopf, eds., Privatization in Transition Economies: The Ongoing Story (Elsevier, 2008) K. Fabian, ed., Globalization: Perspectives from Central and Eastern Europe (Elsevier, 2007) J. Laible and H. J. Barkey, eds., European Responses to Globalization: Resistance, Adaptation and Alternatives (Elsevier, 2006) V. Munley, R. Thornton, and J. R. Aronson, eds., The Irish Economy in Transition (Elsevier, 2002) F. Gunter and C. Callahan, eds., Colombia: An Opening Economy (JAI, 1999) D. Greenaway and J. Whalley, eds., "Symposium on Liberalisation and Adjustment in Latin America and Eastern Europe," in The World Economy, (Blackwell Publishers, 1994) A. King, T. Hyclak, R. Thornton and S. McMahon, eds., North American Health Policy in the 1990s (John Wiley & Sons, 1993) A. O'Brien and R. Thornton, eds., The Economic Consequences of American Education (JAI, 1993) A. Cohen and F. Gunter, eds., The Colombian Economy: Issues of Trade and Development (Westview Press, 1992) D. Greenaway, R. Hine, A. O'Brien and R. Thornton, eds., Global Protectionism (Macmillan, 1991) E. Schwartz and G. Vasconcellos, eds., Restructuring the Thrift Industry: What Can We Learn from the British and Canadian Models? (1989) D. Greenaway, T. Hyclak and R. Thornton, eds., Economic Aspects of Regional Trading Arrangements (Wheatsheaf Press, 1989) R. Thornton, T. Hyclak and J. Aronson, eds., Canada at the Crossroads: Essays on Canadian Political Economy (JAI, 1988) R. Thornton and J. Aronson, eds., Forging New Relationships among Business, Labor, and Government (JAI, 1986) R. Thornton, ed., Schumpeter, Keynes, and Marx: A Centennial Celebration (1984) R. Thornton, A. Ott and J. R. Aronson, eds., Reindustrialization: Implications for U.S. Industrial Policy (JAI, 1984)

For information on Martindale Center publications, please write to the Center at:
621 Taylor Street Lehigh University Bethlehem, PA 18015