Chevron’s Earnings Decline On Lower Oil Prices But Production Outlook Intact

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Chevron

Chevron (NYSE:CVX) recently announced its 2014 fourth quarter and full-year earning results. As expected, lower oil prices and flat upstream production, partially offset by thicker downstream margins, resulted in lower earnings for the company. Its fourth quarter earnings per share (EPS) declined by more than 28% year-on-year to $1.85.  On expected lines, the company also announced a cut in its capital-spending budget for the year, primarily because of the changed crude oil price environment. It plans to spend less on risky exploration ventures this year, and also potentially defer some not-so-lucrative development prospects until there is some more clarity on the medium-term outlook for crude oil prices. However, the company did reaffirm its short to medium term production growth outlook citing good progress being made on the key projects under construction that are expected to drive its average daily net hydrocarbon production to 3.1 million barrels of oil equivalent per day (MMBOED) by 2017 from around 2.6 MMBOED currently. [1]

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 $20 billion with a consolidated adjusted EBITDA margin of almost 24.4%. Based on the recent earnings announcement, we have revised our price estimate for Chevron to $114/share, which is almost 13.1x our 2015 full-year adjusted diluted EPS estimate for the company.

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Thicker Downstream Margins

Chevron’s downstream margins improved significantly during the fourth 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 fourth quarter international downstream earnings increased by more than 400% year-on-year. We expect a similar performance to continue during the next few quarters. [2]

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)

Upstream Production Outlook Intact

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. [3]

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 fourth quarter earnings call, Chevron announced that the project is 90% complete and is on track for recording first LNG sales by the end of this year. It is expected to reach the peak production capacity by 2017 after all of 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 tons per annum (MTPA) of LNG at its peak capacity. Chevron noted during the recent earnings call that the Wheatstone project is now 55% 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 last year due to a pipeline rupture, should restart in the second half of this year. (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. With a planned production life of more than 30 years, the first stage of development that completed in December last year at a cost of around $7.5 billion, is anticipated to recover in excess of 500 million oil-equivalent barrels from the two fields. Chevron also holds a 42.86% stake in the Tubular Bells project. First production from the project, which is expected to deliver around 50 thousand barrels of oil equivalent per day at its peak, was announced in November 2014. Production from both the recent start-ups in the Gulf of Mexico will be ramped up this year. (See more on Chevron’s Deepwater prospects: Chevron’s Deepwater Production To Receive A Boost From The Start-up Of Jack/St. Malo)

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Notes:
  1. Chevron 2014 Q4 Earnings Release, chevron.com []
  2. Chevron 2014 Q4 Earnings Call Presentation, chevron.com []
  3. Chevron 2014 Q4 Earnings Call Transcript, chevron.com []