UPDATE 2-Occidental CEO wields axe over ballooning costs

* Third-quarter earnings beat analysts' estimates

* U.S. output rises to 469,000 from 462,000 in second quarter

* CEO targets cut in costs to 2011 levels next year

* Shares up 1.4 percent

Oct 25 (Reuters) - Occidental Petroleum Corp posted a smaller-than-expected drop in quarterly earnings on Thursday, but its CEO hardened his tone on operating expenses and promised a change in strategy if they do not come down.

Chief Executive Officer Stephen Chazen set a target of lowering costs to 2011 levels by the end of next year, zeroing in on those in the company's home state of California.

The improvements and the resulting rise in the fourth-largest U.S. oil company's share price must come in early 2013, he said. The stock is down 13 percent so far in 2012, while Exxon Mobil Corp and Chevron Corp are up for that period.

``If I don't see real improvements in the returns, you know, in the next couple of quarters, strategy will change,'' Chazen told analysts on a call, saying that could take the form of higher dividends or even farming out wells to other companies.

He saw plenty of room for more efficiency in California, which accounts for about a third of Oxy's U.S. production and nearly half its active U.S. rig count. He had already made management changes and was tightening the purse strings as well.

``The operating costs that they're running in California don't make any sense to me,'' he said. ``They were running a lot less -- half -- two years ago. And they need to be back to that. If they do that, they'll have plenty of capital to drill the wells.''

Third-quarter net profit fell to $1.38 billion, or $1.69 per share, from $1.77 billion, or $2.17 per share, a year earlier. Analysts on average had expected $1.63 per share, according to Thomson Reuters I/B/E/S.

The profit beat resulted from higher-than-expected U.S. oil production and lower unit costs, according to Sterne Agee analyst Tim Rezvan.

Worldwide oil output rose 4 percent from a year earlier to the equivalent of 766,000 barrels per day. This included an average of 469,000 bpd in the United States, up from 462,000 in the second quarter.

Chazen said U.S. oil output would rise by about 6,000 to 8,000 bpd of oil in the fourth quarter, but the increase would be offset by falling natural gas output stemming from low prices for that fuel.

The average Brent oil price of $110 per barrel in the third quarter was down $2 from a year earlier and up just $1 from the second. Benchmark U.S. natural gas prices fell 32 percent from a year earlier to an average of $2.83 per million British thermal units as huge supplies weighed down that market.

Occidental shares rose 1.4 percent to $81.79 in afternoon New York Stock Exchange trading.