Chevron’s Earnings Rise On Thicker Downstream Margins; Production Outlook Intact

Chevron’s (NYSE:CVX) third quarter earnings rose higher on thicker downstream margins and gains on asset disposition, despite lower crude oil prices. The company’s diluted earnings per share (EPS) increased almost 14.8% year-on-year to $2.95. Chevron’s crude oil price realizations fell 10.4%, compared to the previous year’s quarter on lower benchmark prices. Global crude oil benchmark prices have fallen sharply over the past few weeks on rising supplies and slower demand growth, especially from China, where the rate of growth in demand for petroleum products has fallen to almost half of what it was a year ago. However, thicker downstream margins more than offset the impact of lower crude oil prices, reflecting the inherent strength of the integrated business model in times of volatile commodity prices. ^[1]

Chevron’s third quarter upstream production was down marginally by around 0.7% y-o-y, as growth from the continuing development of shale and tight resources and the ramp-up of recently started projects was more than offset by the impact of asset sales, lower production entitlements, and normal field declines. However, the company reaffirmed its short to medium term production growth outlook citing progress on the key projects that are expected to drive its average daily hydrocarbon production rate to 3.1 million barrels of oil equivalent per day (MMBOED) by 2017 from around 2.6 MMBOED currently. ^[2]

Chevron is the second largest energy company in the U.S. after Exxon Mobil. The company manages its investments in subsidiaries and affiliates, for which it provides administrative, financial, management and technological support.  This extends both to its U.S. subsidiaries and to its international subsidiaries, engaged in fully integrated petroleum, chemicals and mining operations, as well as power generation and energy services. It generates annual sales revenue of around $230 billion with a consolidated adjusted EBITDA margin of ~21.8%. Based on the recent earnings announcement, we have revised our price estimate for Chevron to $120/share, which is almost 11.4x our 2014 full-year Non-GAAP diluted EPS estimate for the company.

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Thicker Downstream Margins

Chevron’s downstream margins improved significantly during the third quarter on lower benchmark crude oil prices and supplier discounts. Because of the sharp increase in crude oil production in the U.S., primarily because of increased tight oil development, imports by the world’s largest oil consuming nation have been declining recently. As a result, oil exporting countries like Saudi Arabia are looking for buyers elsewhere and offering discounts to benchmark prices in order to their retain market share. ^[3] This oversupply scenario is benefiting refineries in Europe and Asia because of which, Chevron’s third quarter international downstream earnings increased by more than 340% year-on-year. We expect a similar performance during the fourth quarter to boost its full-year downstream EBITDA margins. ^[1]

However, in the long run, we expect global 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 to sustain employment and reduce their reliance on imported fuels. We currently forecast Chevron’s adjusted downstream EBITDA margin to improve marginally to around 4% in the long run, which is more than 35 basis points below the 2012 level by our estimates. (See: Key Trends Impacting Global Refining Margins)

Improving Upstream Production Outlook

The valuation of an integrated oil and gas company’s upstream division largely depends upon new discoveries of technically and economically recoverable hydrocarbon reserves and ongoing projects that would boost the rate of hydrocarbon production. Although, Chevron’s total oil equivalent hydrocarbon production rate has remained relatively flat around 2.6 million barrels per day since 2006, the short to medium term prospects of the company’s upstream division look bright. This is because it is making some good progress on the key growth projects outlined below.

1. Gorgon LNG: The Gorgon LNG project forms the centerpiece of Chevron’s aggressive production ramp-up plan, as it is expected to contribute over 0.2 MMBOED to Chevron’s net production volume at its peak capacity. The project will source natural gas from the Gorgon and Jansz-lo fields in the Greater Gorgon area, which holds around 40 trillion cubic feet of recoverable resource. During the third quarter earnings call, Chevron announced that the project is 87% complete and is on-track for first LNG production by mid-next year. ^[4] It is expected to reach the peak production capacity by 2017 after all the three LNG trains come online. (See more on Gorgon LNG: A Closer Look At Chevron’s Biggest Bet In The Global LNG Market)

2. Wheatstone, Angola LNG: Chevron is also working on the $29 billion Wheatstone LNG Project, located 12 kilometers west of Onslow on the Pilbara coast of Western Australia. The two-train LNG plant will produce 8.9 million tones per annum (MTPA) of LNG at its peak capacity. Chevron noted during the recent earnings call that the Wheatstone project is now 49% complete and is on-track for a late-2016 start-up. The company also noted that the $10 billion Angola LNG project, which has been offline since April this year due to a pipeline rupture should restart in the second half of next year. ^[5] (See more on Angola LNG: A Closer Look At Chevron’s Angola LNG Project)

3. Gulf of Mexico Deepwater Projects: Chevron is also betting on three deepwater projects, which include Jack/St Malo, Tubular Bells, and the Big Foot, in the Gulf of Mexico to boost its total oil and gas output by 0.1 MMBOE in the short to medium term. The Jack/St Malo deepwater project comprises the joint development of the Jack and St Malo oilfields that are located around 40km away from each other in the Gulf of Mexico. Chevron owns a 50% interest in the Jack field and is also the operator of the St Malo field with a 51% interest. The project is currently on-track for first production by the end of this year. Chevron also holds a 42.86% stake in the Tubular bells project, from which the company said, first production is imminent in the next few days. ^[5] (See more on Chevron’s Deepwater prospects: A Look at Chevron’s Key Deepwater Projects)

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More Trefis Research

1. 2014 3Q Earnings Release, chevron.com [↩] [↩]
2. 2014 3Q Earnings Supplement, chevron.com [↩]
3. NWE Refinery Margins Surge To 18-Month Highs As Crude Oil Prices Plummet, platts.com [↩]
4. 2014 3Q Earnings Conference Call Presentation, chevron.com [↩]
5. ref:1 [↩] [↩]