Chevron Q3 Earnings: Company Focuses On Future Upstream Production Growth And Cost Cutting Amid Low Oil Prices

Chevron (NYSE:CVX) released its Q3 2015 earnings report recently. ^[1] The company has been hit hard by the current downtrend of low crude oil prices and its average price realizations in both upstream and downstream segments have suffered as a result. However, Chevron remains confident of its short to medium term upstream production growth outlook. The company believes that it can increase average daily hydrocarbon production rate to 2.9-3.0 million barrels of oil equivalent per day (MMBOED) by 2017 and expects key projects such as Gorgon, Wheatstone and Angola LNG to provide the majority of volume growth. Chevron is also taking measures to reduce its capital spending and overall cost structure in order to be able to better steer through this commodity trough. We believe that these measures will be beneficial in lifting the company’s cash profit margins as oil prices recover gradually in the long run.

Our price target for Chevron stands at $95, implying a premium of around 5% to the market.

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Upstream Production Growth Outlook Promising, But Oil Prices Currently Hurting Segment

Chevron remains confident of its short to medium term upstream production growth outlook, citing progress on the key projects that are expected to drive its average daily hydrocarbon production rate from around 2.6 MMBOED currently to 2.9-3.0 MMBOED by 2017. ^[2] 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 the company is making some good progress on the key growth projects such as Gorgon, Wheatstone and Angola LNG. These projects are collectively expected to provide the majority of Chevron’s volume growth. The company plans to ship the first cargo form the Gorgon LNG project, which forms the centerpiece of its production ramp-up plan, in the first quarter of 2016. ^[3]

Chevron’s third quarter upstream production was down marginally by around 1.1% year over year, 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. ^[4] Oil prices continue to wreak havoc on Chevron’s upstream operations in 2015. Chevron’s global liquids realizations for the year so far have amounted to $48, almost 50% lower than what the company managed in the year-ago period. ^[4] Based on the current crude oil price environment, we believe that Chevron’s Average Liquids Price Realization will remain below $50 for the year 2015 and will subsequently rise in later years once global oil prices start experiencing a gradual recovery.

Chevron Optimizing Capital & Operational Costs In Low Oil Price Environment

Controlling expenditures, while maintaining modest growth prospects, is the highest priority for Chevron right now, primarily due to the changed crude oil price environment. In the past few years, the company’s total net capital expenditures have soared from around $19.7 billion in 2009 to almost $34.6 billion in 2014. ^[4] Most of the incremental capital expenditures have gone into the development of deepwater hydrocarbon reserves and the construction of giant liquefied natural gas (LNG) plants in Australia, where cost structures have elevated significantly over the past few years due to rising labor costs. The gross cost estimate for the Gorgon LNG project has risen by more than 45% since 2009, and stands at $54 billion today. ^[5]

However, the decline in global crude oil prices has forced the company to increase its focus on optimizing both capital and operational costs in order to maximize its return in the current commodity down cycle. As a result, Chevron has cut down on its capital spending in 2015. Capital expenditure for the first nine months of 2015 amounted to $25.0 billion, a 13% reduction over the prior year period. ^[4] Chevron plans to continue reducing its capital expenditures during the next few years and hopes to bring down the full year capex to $20-24 billion by 2018 depending on business conditions. ^[2] The company is also actively seeking to divest its non-core assets. Chevron has set a divestment target of $15 billion for the 2014-17 period and has already completed $11 billion in divestments as of Q3 2015. ^[6] Additionally, the company is working towards a more efficient cost structure and plans to lay off 6,000 to 7,000 employees and a similar number of contractors. Cost cutting has been a prevalent theme for all major integrated oil companies in the current scenario and we believe that such measures will be beneficial in lifting Chevron’s cash profit margins once oil prices start recovering in the long run.

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1. 3Q 2015 Chevron Earnings Conference Call, October 30, 2015, Chevron Investor Relations [↩]
2. Chevron (CVX) John S. Watson on Q3 2015 Results – Earnings Call Transcript, October 30, 2015, Seeking Alpha [↩] [↩]
3. Chevron to cut jobs amid struggles to keep LNG projects on track, November 2, 2015, Sydney Morning Herald [↩]
4. Chevron’s SEC Filings [↩] [↩] [↩] [↩]
5. More delays for Chevron’s $74bn Gorgon project, August 3, 2015, The Australian [↩]
6. 2015 3Q Earnings Conference Call Presentation, October 30, 2015, Chevron Investor Relations [↩]