California-based Chevron’s (NYSE:CVX) third quarter earnings were down ~6% y-o-y on thinner downstream refining margins, partly offset by higher upstream production and better price realizations. Reported diluted earnings per share (EPS) declined ~5% to $2.57. However, the company’s production outlook remains positive as the major growth projects are on track. 
Chevron is the second largest energy company in the U.S. after Exxon Mobil (NYSE:XOM). The company manages its investments in subsidiaries and affiliates, and provides administrative, financial, management and technological support to its U.S. and international subsidiaries engaged in fully integrated petroleum, chemicals and mining operations as well as power generation and energy services.
We have updated our price estimate for Chevron to $131 based on the third quarter earnings results.
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Thinner Refining Margins
Chevron’s third quarter earnings from the sale of gasoline and other refined petroleum products declined by ~45% y-o-y due to thinner refining margins.  This was more of an industry wide trend during the quarter as global overcapacity amid the sluggish demand scenario coupled with higher crude oil prices, squeezed refining margins.  Furthermore, year-on-year comparison made things look even worse as crack spreads in the prior year’s quarter were significantly higher due to downtime at several refineries under maintenance or being upgraded.  Not only this, higher WTI-Brent spreads also boosted margins for some refiners in the U.S. last year. 
Going forward, we expect refining margins to continue to remain under pressure due to industry overcapacity, which stems from the fact that governments in different parts of the world are willing to run uncompetitive crude refineries at very low or no returns in order to sustain employment and reduce their reliance on imported fuels. 
Better Price Realizations
Better price realizations boosted Chevron’s operating results in the upstream segment. Although average Brent crude spot prices were up only marginally during the quarter, the company’s international liquids realizations improved by more than 6%. Higher commodity prices in the U.S. also helped in improving overall price realizations for the company. Average West Texas Intermediate (WTI) oil prices and Henry Hub natural gas prices were up by ~15% and 25% y-o-y during the third quarter. We forecast crude oil prices to increase in the long run primarily due to incremental demand from emerging economies such as China and India, where growing populations and rising income levels make a solid case for higher energy requirements.
However, we expect international crude prices to increase at a very conservative 2% CAGR in contrast to almost 15% CAGR seen over the last decade. This is because we believe the rising oil production in North America, mostly coming form unconventional sources such as shale oil in the U.S. and oil sands in Canada, will increase the supply of oil from non-OPEC countries significantly, thereby reducing pricing power long held by OPEC countries. The short-term volatility in crude oil prices will remain; however, long-term fundamentals appear to have swung positively for a much smoother demand-supply equation than seen in the past. According to an IEA report, U.S. production is likely to grow by almost 3.9 million barrels of oil per day by 2018, which will change it from the largest importer to a net exporter of oil. 
Higher Production Volume
Chevron’s total net oil-equivalent production increased by ~3% y-o-y to 2,585 thousand barrels per day (MD/day), on lower maintenance-related downtime and project ramp-ups in the United States, Nigeria and Angola. Chevron reported first LNG shipment from the Angola LNG project during the second quarter and is currently ramping up production from the project, which is expected to boost the company’s net oil equivalent production by ~60 MB/day at peak rates. (See: Chevron’s Angola LNG Project Will Help Slake International Gas Demand)
With the key projects on track, we expect Chevron to meet its aggressive production growth target by 2017. The company officials announced during the third quarter earnings call that the Gorgon Project is more than 70% complete and is on track for delivering the first shipment in 2015.  The project includes the construction of a 15.6 million ton per annum (MTPA) LNG plant on Barrow Island and a domestic gas plant with the capacity to supply 300 Tera-Joules of gas per day to Western Australia. The LNG facility will ensure easy transportation of natural gas to the fast growing Asian economies. The Gorgon project forms the centerpiece of Chevron’s production volume ramp-up plan. It is expected to add over 200 MB/day to the company’s net production volume. Apart from Gorgon, the Wheatstone project in Australia, which is expected to start operations by 2016, will also boost the company’s LNG production volume.Notes:
- Chevron Reports Third Quarter Net Income of $5.0 Billion, investor.chevron.com [↩] [↩]
- Weekly Refining Indicators Report, howardweil.com [↩]
- Refinery Margins, bp.com [↩]
- Brent-WTI Oil Spread Collapse Spooks Refiners, Railways, cnbc.com [↩]
- Global overcapacity to squeeze oil refining margins: Campbell, reuters.com [↩]
- US shale oil supply shock shifts global power balance, bbc.co.uk [↩]
- 3Q 2013 Chevron Earnings Conference Call, investor.chevron.com [↩]