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Chevron: ready for the rebound

Having weathered the downturn in impressive fashion, Chevron is well placed to take advantage of any Iran supply shock

Chevron has performed well of late. The US oil and gas giant posted earnings of $3.4bn for Q2 2018, a marked improvement on the $1.5bn the company reported in the same period last year. Its impressive financials are the result of "higher crude oil prices, strong operations and higher production", according to chief executive Michael Wirth.

However, despite Chevron's earnings more than doubling over the past 12 months its performance missed Wall Street expectations. According to S&P Capital IQ, consensus second-quarter earnings for Chevron were estimated at $2.07 per share, only to come in at $1.78, 16% lower than most analysts were predicting. It's worth noting that Chevron isn't alone, many other oil companies fell below analysts' forecasts.

Overall though, Chevron's results were very promising, particularly with regards to its oil output growth. In Q2 2017, worldwide upstream production grew by around 10% year-on-year to $2.78m barrels a day.

Output rose slightly in the second quarter of this year to £2.83m b/d, with growth from project start-ups and ramp-ups offset by asset sales and production entitlement effects. Comparatively, the company's production growth in the context of other mega-cap multinationals is in good shape, according to Pavel Molchanov, energy research analyst at Raymond James, a financial services firm. Despite the price of global crude being up by around 50% on last year, rival ExxonMobil saw its production of oil and natural gas decrease by around 7%, while Chevron's increased by 2%, allowing it to take full advantage of the higher oil price. This represents a "huge gap in operational performance" between the two companies, says Molchanov, adding that Chevron has similarly outperformed several other major players.

Diversified portfolio 

In recent years, Chevron's impressive production growth is primarily the result of investments in Australian liquefied natural gas and the prolific Permian Basin. It has also benefited from a diversified portfolio, with high-growth assets in Kazakhstan, Nigeria and Mozambique all generating strong cash flow. In January, Chevron announced another major oil discovery at the Ballymore prospect in the deep-water Gulf of Mexico.

Meanwhile, in Australia, the company launched the Gorgon Project, one of the largest undertakings the sector has ever seen. This development boasts total production capacity of around 2.6bn cubic feet a day of natural gas and around 20,000 b/d of condensate. Chevron announced in April that it would move forward with the second stage of its Gorgon LNG development off the north-west coast of Western Australia, spudding 11 new wells in the Gorgon and Jansz-Io fields.

But above all, it's US shale from the Permian Basin that holds the key to Chevron's long-term growth, with the oil and gas major expecting production to increase from 200,000 barrels of oil equivalent a day to 500,000 boe/d by 2020, and as high as 600,000 boe/d by 2022. "We intend to grow free cash flow in 2018 and thereafter," Wirth said in March this year. "Even with no commodity price appreciation, we expect to deliver stronger upstream cash margins and production growth."

2.83m b/d – Chevron’s Q2 2018 output

US investors have a strong preference for shale assets, in part because of lower operational costs. But developments also have much shorter cycles when compared with offshore crude oil extraction, another US-based energy analyst says. Shorter cycles also allow Chevron to activate and deactivate oil production more efficiently, allowing them to take advantage of oil prices surges and help mitigate exposure to the market when prices fall.

In the analyst's view, the looming logistical constraints that threaten to slow production in the Permian Basin will lead to significant discounts for local crude compared with international benchmarks. This gives integrated oil and gas companies a strong advantage. Therefore, majors like Chevron effectively benefit from an internal physical hedge on the differential, making a strong case for ongoing investment in the region, given current market conditions.

Balancing act

The management team at Chevron has had to contend with serious headwinds, notably an oil crash which slashed benchmarks Brent and West Texas Intermediate from over $100 a barrel to $62 and $59 respectively in Q4 2014. Over the past four years, Chevron's board has successfully balanced growthin a sector where constant investment is necessary to drive productionwhile continuing to return capital to its shareholders.

During the slump, Chevron suspended share buy-backs and cut capital spending, as did many other players in the sector. However, much to the delight of their investors Chevron didn't cut dividends, as some of its rivals such as ConocoPhillips were forced to do. Most recently, despite missing earnings expectations in Q2 2018, Chevron's management initiated a $3bn a year share buy-back programme.

Opting to prioritise shareholders has also meant that, unlike many of its competitors, Chevron hasn't made large-scale M&A a major priority over the past four years. At one time the firm was an aggressive buyer, acquiring Unocal in a deal valued at $17.9bn and completing a $36bn mega-merger with Texaco.

While Chevron has remained relatively quiet from an M&A perspective, rival Exxon has been very active, buying more than 250,000 acres in the Permian Basin from the Bass family of Fort Worth late last year. More recently, Exxon completed its purchase of the Carcara oilfield interest off Brazil and has bought up LNG assets in Mozambique. Exxon's spending spree, the analyst says, "stems from its much weaker upstream growth portfolio and lower production rates, compared to rivals like Chevron".

2.6bn cubic feet a day – Gorgon natural gas production capacity

Chevron, like any oil and gas major, will continue to carry out routine portfolio management, selling off assets, as it has done in the UK North Seanow seen as a non-growth area by many in the sector. The capital raised from asset sales, Molchanov says, will then be reinvested in existing projects, especially in short-cycle opportunities in the Permian Basin and the Tengiz expansion in Kazakhstan, as well as in the Vaca Muerta shale assets in Argentina.

Because of all the opportunities that Chevron has created, both analysts agreed, there's little need for the company to pursue large-scale M&As. Indeed, it would be a surprise to see its management allocate capital for major inorganic growth plans.

As with every other player in the market, the only real threat to Chevron is the oil price. Right now, prices are in a relatively strong position and the company's production is well placed to take full advantage of the current climate. Malchanov doubts that oil prices will break through the $100 mark again. But the market is bracing itself for a major supply shock that could see crude prices rally above $90, with the possibility of a drop in Iran's production.

If this happens, Chevron will reap the rewards of successfully managing its emergence from the last downturn. It's well positioned for any upswing the market might see in the second half of this year.


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