Chevron Preview: Lower Oil Prices, Flat Production To Weigh On Upstream Earnings
Chevron (NYSE:CVX) is scheduled to announce its 2014 fourth quarter earnings on January 30th. We expect lower crude oil prices to weigh significantly on the company’s upstream earnings growth. Benchmark crude oil prices have declined sharply over the past few months on rising supplies and falling demand growth estimates. The average Brent crude oil spot price declined by more than 30% year-on-year during the fourth quarter. In addition, Chevron’s net upstream production is also expected to remain relatively flat year-on-year. However, we expect thicker downstream margins, primarily driven by the improvement in the global refining environment, to partially offset the impact of lower oil prices on the company’s overall performance. During the earnings conference call, we will be looking for an update on Chevron’s ongoing new project development, specifically the Gorgon liquefied natural gas (LNG) project in Australia that is expected to come online later this year. We will also be looking for an update on its operating strategy under the changed crude oil price environment.
California-based 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, 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%.
We currently have a $114/share price estimate for Chevron, which is almost 13.2x our 2015 full-year adjusted diluted EPS estimate for the company.
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Flat Upstream Production
We expect Chevron’s average daily net upstream production to be relatively flat during the fourth quarter, compared to the year-ago quarter, as increased liquids (crude oil and natural gas liquids) production from tight oil plays in the U.S. and Argentina is expected to be mostly offset by lower production from Angola, due to a shut project, and Chad due to a recent divestment. We expect Chevron to continue to make good progress on its shale and tight resources development program. The company is the largest undeveloped leaseholder in the Permian region with approximately 2 million net acres and 17,000 drilling prospects. It has been an operator in the region since the 1920s and this legacy position provides it with the critical access to marketing infrastructure. More importantly, Chevron is not in a drill or drop situation in the region, which will allow it to withstand lower crude oil prices without sacrificing on profitability. During the third quarter, the company’s net upstream production received a boost of 40 thousand barrels of oil equivalent per day (MBOED) from increased unconventional development in the Permian and the Vaca Muerta shale in Argentina. We expect to see a similar growth in production during the fourth quarter as well. In addition, we also expect a continued production ramp up at the Papa Terra project offshore Brazil, which started producing oil in November 2013, to boost Chevron’s net upstream volumes during the quarter. [1]
However, the decline in base production coupled with the shutdown of the Angola LNG project due to technical issues, and the recent divestment in Chad, is expected to mostly offset the company’s fourth quarter production growth from new projects. Chevron’s $10 billion Angola LNG project has been plagued with several issues since its startup in mid-2013 due to a series of technical faults including electrical fires, pipeline leaks, and a slower than expected ramp-up of the downstream processing facility. In its latest annual SEC filing, the company noted that the project would be operating at around 50% of its peak capacity till 2015, when it expects to complete the required modifications to fix these technical issues. However, the plant has been offline since April 2014 due to a pipeline rupture, and Chevron now expects it to restart only by around mid-2015. [2] Chevron is the operator of the project with a 36.4% working interest. The company also announced the sale of its interest in some oil fields and pipelines in Chad to the country’s government for around $1.3 billion in June 2014, which will further reduce its net upstream production growth during the fourth quarter. Chevron’s average daily net crude oil production from these assets stood at 18,000 barrels in 2013. [3]
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 retain their market share. 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. [4]
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 increase 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)
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Notes:- 2014 3Q Earnings Conference Call Presentation, chevron.com [↩]
- Angola LNG Outlines Plan To Address Issues At The Plant, angolalng.com [↩]
- Chevron Announces Sale Of Interests In Chad And Cameroon, chevron.com [↩]
- 2014 3Q Earnings Release, chevron.com [↩]