What To Expect From Chevron In 2014?

Chevron (NYSE:CVX) has had a relatively stable year so far. Although the company’s stock has underperformed the S&P 500, which has grown by more than 20% this year, it has fared much better than its peers amid industry-wide weakness in the downstream business. Almost all the integrated oil and gas companies, including Exxon Mobil (NYSE:XOM), Shell (NYSE:RDS) and BP (NYSE:BP), have suffered from thinner downstream operating margins this year because of industry overcapacity. However, Chevron has fared relatively better under the circumstances as it has delivered better upstream production numbers so far.

We believe that Chevron’s next year earnings growth would also largely depend on its upstream production growth and commodity prices as the refining business is expected to remain under pressure. Apart from this, progress on the Gorgon LNG project, which forms the centerpiece of Chevron’s aggressive production growth plans, will be a key area of focus next year. We will also be closely tracking the progress on its capital and exploratory expenditures budget, which has been swelling over the past few years.

We currently have a $123 price estimate for Chevron, which values it at around 10x our 2014 GAAP EPS estimate of $12.11, and is ~5% above its current market price.

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Robust Production Outlook

While Exxon, Shell and BP have seen their production output fall by 1-2% during the first nine months this year, Chevron has been able to grow its total net production slightly. ^[1] The company expects to boost its total upstream production by more than 20% to 3,300 thousand barrels of oil equivalent per day (MBOED) by 2017 from around 2,610 MBOED in 2012.

Chevron is working on a number of capital projects aimed at achieving this target. Earlier this year, it reported first shipment from the $10 billion Angola LNG project, in which it holds a 36.4% stake. The LNG plant is currently operating at just around 20% of its full capacity due to supply side constraints. However, Chevron plans to ramp up the project to full capacity by the end of next year, which should boost its natural gas production volumes. ^[2] (For more details on the project see: Chevron’s Angola LNG Project Will Help Slake International Gas Demand)

It also holds a 37.5% stake in the Petrobras-operated Papa Terra deep-water project, which started producing last month. The Papa Terra project is estimated to recover around 350 million barrels of oil over time and has a peak production capacity of 140 MBOED. ^[3] Apart from this, the company is also working on three other deep-water projects in the Gulf of Mexico. Of these, the Jack/St. Malo project is expected to come online next year, while the Big Foot project would only start producing in the second quarter of 2015. ^[4]

Chevron is also developing a gas to liquids plant in Nigeria based on its Isocracking technology, which is expected to start producing by next year. The project would convert more than 325 million cubic feet of natural gas every day into diesel and naphtha. However, the Chevron-operated $6.4 billion Chuandongbei sour gas project in China is facing further delays due to disagreements with PetroChina over how to develop the technically tricky fields. The project is now not expected to start delivering gas until the second half of 2014. ^[5]

All of these projects are together expected to add more than 200 MBOED to Chevron’s total net production by the end of next year. Beyond 2014, Chevron’s net production growth would largely depend upon the Gorgon and the Wheatstone LNG projects in Australia. A total of 5 LNG trains under construction in Australia are expected to boost Chevron’s total net production by as much as 400 MBOED at full capacity. (See: A Closer Look At Chevron’s Biggest Bet In The Global LNG Market)

Thinner Refining Margins

During the first nine months of the year, Chevron’s earnings from the sale of gasoline and other refined petroleum products declined by ~45% y-o-y due to thinner refining margins. ^[6] This has been more of an industry-wide trend this year as global refining overcapacity amid the sluggish demand scenario coupled with higher crude oil prices, squeezed refining margins. ^[7] 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. ^[8] Not only this, higher WTI-Brent spreads also boosted margins for some refiners in the U.S. last year. ^[9]

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. ^[10]

Swelling Capital Expenditures

Chevron’s net capital expenditures have soared from around $17 billion in 2009 to over $28 billion in 2012. The company also expects to exceed its capital budget for 2013 by more than $4 billion due to unplanned resource acquisitions in Canada, Australia and the Kurdistan region of Iraq. For the first nine months of the year, Chevron’s capital expenditures stood at $26.4 billion, while its cash flow from operations stood at just $24.6 billion during the same period. ^[11]

However, the company is looking to slightly tone down capital investments next year as it plans to reverse the growing trend in favor of higher cash flows. According to the recently announced capital budget plan for 2014, Chevron looks at spending around $2 billion less on leasing rigs, floating oil platforms, installing pipelines and repairing oil-refineries than it did this year.

We believe that it could be a tough target for the company to achieve amid rising construction costs in Australia, as it inches closer to the Gorgon LNG project start-up. Last year, Chevron announced a sharp $15 billion or a 40% spike in the total cost estimate for the project from $37 billion in 2009 to $52 billion. This year, it has further increased the total cost estimate by another $2 billion. The estimates have gone up primarily due to rising labor costs, a stronger Australian dollar, productivity issues at the Barrow Island site, and weather delays.

While a lower capital expenditure budget is a positive sign for investors, we still remain cautious of further cost escalations and start-up delays, especially at the Australian LNG projects, and have factored in a slippage of $2.5 billion in our model. However, it should be noted that our price estimate is extremely sensitive to capital costs incurred by the company in a given period, and if it is able to control capital expenditures to the budgeted amount for 2014, there could be ~10% upside to our current price estimate.

Understand How a Company’s Products Impact its Stock Price at Trefis

1. SEC Filings, sec.gov [↩]
2. Angola LNG Output At 20% Capacity, Full Run End-2014-Sonagol, reuters.com [↩]
3. Jefferies 2013 Global Energy Conference, chevron.com [↩]
4. Chevron Announces $39.8 Billion Capital and Exploratory Budget for 2014, chevron.com [↩]
5. Chevron’s $6.4 Billion China Gas Project Pushed Back Again, reuters.com [↩]
6. Chevron Reports Third Quarter Net Income of $5.0 Billion, chevron.com [↩]
7. Weekly Refining Indicators Report, howardweil.com [↩]
8. Refinery Margins, bp.com [↩]
9. Brent-WTI Oil Spread Collapse Spooks Refiners, Railways, cnbc.com [↩]
10. Global overcapacity to squeeze oil refining margins: Campbell, reuters.com [↩]
11. Chevron SEC Filings, sec.gov [↩]