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Chevron pleads for investor patience as results improve

Supermajor Chevron hopes investors will stick with the firm as it invests in significant oil and gas output growth from 2014

After a disappointing third quarter, Chevron appears to be bouncing back. In a fourth-quarter interim update, it said upstream results have improved on the back of higher oil prices and robust demand, while downstream earnings are also expected to rise, reflecting gains from asset sales.

Chevron's production for October and November was about 2.77m barrels of oil equivalent a day (boe/d), up from 2.74m boe/d in the third quarter and tantalisingly close to its targeted average 2010 production of 2.78m boe/d, or 3% growth over 2009 – having raised that goal from a 1% growth target set in March.

The figures put Chevron back on track after a disappointing third quarter, when the US' second-largest oil firm saw profits fall by 1.6% to $3.77bn, or $1.87 a share, from $3.83bn, or $1.92 a share, in the year-earlier period. That was $0.28 less than the average analyst estimate compiled by Bloomberg and bucked the trend of the other US majors – ExxonMobil saw its third-quarter profit rise by 55%, while ConocoPhillips more than doubled profit during the period.

Chevron's chief executive officer, John Watson, blamed the third-quarter dip on higher exploration costs – including "significant" write-offs on failed wells in Turkey and Canada; the effects of the drilling moratorium in the US Gulf of Mexico (GOM), following the Deepwater Horizon disaster; as well as foreign-currency losses that were more than double the year-earlier period.

These negatives were largely offset by higher oil and gas prices, and an increase in worldwide production. Oil and gas output inched 1.3% higher on the year, to 2.74m boe/d, in the third quarter, lifting revenues by 6.6%, compared with third-quarter 2009, to $49.72bn. Given that 2010 also included one-off gains of around $400m from asset sales and tax items, Watson stressed that Chevron's third-quarter earnings were essentially flat.

Investors were less forgiving, selling down the shares by 2.2%, to $82.60, on the day of the earnings release. "In the grand analysis, Chevron's earnings fell by 1.6% year on year, no matter how the numbers are cut," says Andrew Neff, of IHS Global Insight.

Such hiccups are particularly fraught for Chevron because it is implementing a strategy that could pay big future dividends, but may be tricky to pull off. In essence, Chevron is telling shareholders to be patient while it ploughs money into its exploration and production (E&P) division, assuring them of a big payout from 2014.

The company is planning a capital-spending and investment budget of $26.0bn for 2011, up by 20% over the previous year, as it seeks to under-pin long-term production growth. Around 85% of the total will go to E&P, a 31% increase over 2010.

The savings will come from the struggling downstream business that Chevron is busy restructuring. It is selling assets, reducing refining capacity and shrinking its retail network – it sold its fuels-marketing and aviation businesses in the Caribbean in November and is in the process of selling its downstream assets in Africa.

"Chevron seems to be ahead of the competition in reorganising to address structural problems affecting downstream operations," says Hirokazu Kabeya, an analyst at Daiwa Capital Markets. Together with the E&P boost, Kabeya adds, Chevron's strategies "are strong in terms of both offence and defence, which should be a positive for the stock".

To see where Chevron is spending the money, look no further than the $4bn, deep-water GOM Big Foot project, sanctioned in December. Big Foot should be completed by 2014, producing 75,000 b/d of oil and 25m cubic feet a day (cf/d) of gas. This announcement came just two months after the company approved another GOM deep-water development, the $7.5bn Jack and St Malo, which should be on stream by 2014, flowing 170,000 b/d of oil and 42.5m cf/d of gas.

"Chevron is essentially betting that it has the financial wherewithal and safety record to take on more deep-water projects in the GOM, as the rewards outweigh the risks. Political risk in the GOM, while higher than before Deepwater Horizon, is still lower than in many countries, such as in west Africa, or Latin America – where Bolivia, Venezuela and Ecuador are re-nationalising assets," says Neff.

Equally crucial to Chevron's long-term production outlook is Australia. The company's Gorgon and Wheatstone liquefied natural gas projects, in Western Australia, are expected to add up to 0.71m boe/d to the company's production after 2016. Gorgon, the more expensive of the two, with projected costs of $37bn, is scheduled to start up in 2014; with Wheatstone, costing around $20bn, expected on stream two years later.

Gorgon's and Wheatstone's combined 45 trillion cf of gas will play a significant role in powering the fast-growing economies of China and India, as well as servicing Japan and South Korea's needs. Given expected strong economic growth in Asia, Chevron is undertaking gas projects in Indonesia, Thailand and Vietnam.

Focus on gas

In all, the company is looking to boost the proportion of gas in its total production from 31% to 41% by 2017. And it is not only Asia where it aims to boost its gas business. In November, Chevron followed ExxonMobil and Shell into the US northeast's Marcellus Shale play through a $3.2bn deal for gas producer Atlas Energy. The take-over, which must be approved by Atlas's shareholders, would give Chevron access to 0.85 trillion cf of proved shale-gas reserves.

All this costs money – and a lot of it. But Chevron has a strong balance sheet and a low debt-to-capital ratio, despite recently rising debt, and strong cash flow from operations should be sufficient to fund investments and pay dividends.

"Historically, management has demonstrated restraint and discipline by not chasing investments as commodity prices rose. Armed with a strong balance sheet and a stable of growth projects, Chevron is likely to thrive regardless of oil prices," reckons stock-rating company Morningstar.

So Chevron is laying the groundwork for strong output growth from 2014, but this "be patient" strategy exposes the company to the risk that short-term hiccups will be exacerbated and investors lose faith.

Analysts believe investors will give the company some leeway, so long as there is positive output growth this year and its megaprojects remain on track. "But any slippage in the timetable, or unexpected drop in production could put the company under pressure to perform better, in terms of higher dividends, or share-price increases," says Neff. "Plus, any decline in oil prices that cuts into profits will make it harder for Chevron to sell investors on its 'wait until 2014' approach."

So far, investors are buying into Chevron's vision. The shares posted a 52-week high of $92.48 on 3 January, meaning the stock has hit a new year high 22 times in the past three months – a significant uptrend in anybody's book.

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