Why do Chevron s capex projects determine production growth? By Keisha Bandz May 16, 2014. 02:00 PM Chevron Corporation: A must-know brief overview Chevron Corporation C hevron C orporation (C VX), headquartered in San Ramon, C alifornia, is an energy company engaged in exploration and production, refining, marketing, and transportation of oil and gas across more than 180 countries. It s also involved in geothermal and chemical manufacturing and sales, as well as power generation. C VX s operations are divided into two segments: Upstream and Downstream. The Upstream segment is involved in the exploration, development, and production of crude oil and natural gas. The Downstream segment engages in refining crude oil into petroleum products, which are then marketed and transported through pipelines, marine vessels, motor equipment, rail cars, etc. C hevron also engages in transportation, storage, and marketing of natural gas.
C hevron s upstream operations are based primarily in the U.S., Australia, Nigeria, Angola, Kazakhstan, and the Gulf of Mexico. Its downstream operations are based primarily in the West Coast of North America, the U.S. Gulf Coast, Southeast Asia, South Korea, Australia, and South Africa. CVX is currently trading at EV-to-2014E EBITDA of 5x and has a market cap of ~$239 billion and an enterprise value of ~$245 billion. Select ETFs which hold C VX include Energy Select Sector SPDR Fund (XLE), Vanguard Energy ETF (VDE), SPDR S& P Oil & Gas Exploration & Production ETF (XOP), and ishares U.S. Energy ETF (IYE). On May 2, C hevron C orporation (C VX) announced earnings for the first quarter 2014 ended March 31, 2014. This was followed by an earnings report released in March. Read the following parts of the series to know how CVX performed in Q1 2014. Why did Chevron miss its earnings estimates in 1Q 2014? Chevron s earnings missed Wall Street consensus estimates C hevron s quarterly revenue for Q1 2014 was $49.03 billion. On a year-over-year basis, this represented a decline of 6.2%, and compared with the consensus estimate which was $53 billion, it was a miss of 7.5%. C VX s adjusted earnings amounted to $4.5 billion. On a year-over-year basis, this represented a decline of 26%, and on a quarter-over-quarter basis, it represented a decline of 8%. This is the ninth consecutive quarter, where C hevron has missed its estimates. The company reported $2.36 earnings per share (or EPS) for Q1 2014, down from previous year s $3.18 by ~26%, missing the $2.51 consensus estimate by $0.15.
This decline in earnings was expected thanks to the interim update that CVX had provided for its 1Q14 earnings on March 31, 2014. C hevron anticipated a decline in earnings, due to harsh weather conditions, exchange rate fluctuations, or unfavorable foreign exchange rates, asset impairment charges, and a fall in production from upstream and downstream segments. C VX had expected to report a negative foreign currency impact of $100 million for the quarter. For context, in 4Q13, C hevron reported a positive foreign currency impact of $200 million. The actual impact of the foreign exchange fluctuation was $225 million, way higher than what was expected. That negatively impacted upstream earnings. On a segment-wise basis, the worldwide upstream segment s earnings declined by 27% yearover-year to $4.31 billion due to lower crude oil and natural gas production and price realization, along with higher exploration expenses. As per the company report, average sales price per barrel of crude oil and natural gas liquids was $99 in the latest quarter, down from $102 a year ago. According to the report, crude prices were affected by global economic factors. P lus, production fell by 2.3% year-over-year this quarter to 2.59 million barrels of oil equivalents per day. The report stated that current year s production was affected by harsh weather conditions especially in Kazakhstan. Exploration expenses and negative foreign exchange fluctuations were also major causes for the decline in production. On a quarter-over quarter basis, the U.S. upstream earnings were up by $109 million. This was primarily due to higher realization on account of the rise in the U.S. natural gas prices. Higher realizations increased earnings by $130 million. However, the positives were offset by negatives like harsh weather conditions, exploration expenses, and negative foreign exchange fluctuation. Even the rising natural gas prices, which curbed the total decline to some extent, couldn t help C VX achieve increased earnings. So, declining production was largely the reason why C hevron missed its earnings estimates.
International Upstream segment earnings were also down by 29%, to $3.4 billion compared to the previous year and down by 15% compared to the previous quarter. The decrease was again due to lower crude oil production and realizations. Foreign exchange fluctuation was also responsible for the decline as negative foreign currency earnings of $355 million impacted the segment.
The earnings of the Downstream segment, which includes refining, marketing and chemical operations, were up 1.3% year-over-year to $710 million. This was due to higher refining margins and lower operating expenses. However, the company reported a decline in refinery input due to harsh weather and increased maintenance activities at multiple refineries. The U.S. refinery input declined 0.9% quarter-over-quarter to 863,000 barrels per day (BP D). On a quarter-over-quarter basis, the U.S. Downstream results increased $157 million, this was largely because the chemicals segment s performance increased by $80 million in 1Q14 versus 4Q13. P lus, operating expenses (or opex) was $95 million lower quarter-over-quarter.
The International Downstream segment also fared well in this quarter. Its earnings were up 130%, to $288 million largely because of higher refinery margins and positive foreign exchange movements of $70 million.
So, both the U.S. and International Upstream segments performances pulled down C hevron s overall earnings largely because of lower crude oil production and realizations. Major oil companies like C hevron, ExxonMobil, etc., faced production challenges. During the first two months of the quarter, average oil and natural gas production in the U.S. fell 4.2% from the same period last year to 637,000 barrels of oil equivalent per day (BOE/D). Realized oil price in the U.S. declined 3.4% on a yearly basis, to $91.26 per barrel (bbl), whereas realized price for natural gas improved by 51.1% during the same period, to $4.7 per thousand cubic feet (MCF). Note that Chevron is a part of the Energy Select Sector SPDR Fund (XLE), Vanguard Energy ETF (VDE), SPDR S& P Oil & Gas Exploration & Production ETF (XOP), and ishares U.S. Energy ETF (IYE). Major capital projects Despite the lower volumes, outlook for C hevron s production remains positive, thanks to its major growth projects that are stated to come online soon and boost production by 20% by 2017 (more on this in the following parts of the series). Another reason why investor outlook for C hevron s growth may be positive is because of the 7% increase in the quarterly dividend, to $1.07 per share, which was announced On April 30. Currently, CVX stock pays 8% dividend, resulting in a yield of 3.4%. Capital expenditure C hevron is currently investing very large sums into capex projects to grow production, as the company expects to spend $40 billion in capex this year. Based upon current oil prices, the company is projected to outspend its operating cash flow. C hevron expects massive returns from these investments. However returns from investments are dependent on future oil and natural gas prices, as well as the volume of production generated from the capex projects. Also, to offset
the massive cash needs required to finance these investments, C hevron is targeting roughly $10 billion in divestments for the period 2014-2016. Total debt for the quarter increased by $2.6 billion, to $23 billion. Share repurchases C hevron also has a stock repurchase program under which it repurchases its own stock from shareholders in exchange of cash, which are then either retired or available for re-issuance. As part of the stock repurchase program, C hevron repurchased $1,250 million worth of shares in the first quarter and expects to repurchase the same amount in the second quarter. Stock performance Investors were expecting the weak earnings posted by C hevron due to the interim report provided a month ago. Stock price movements remained flat. P ost the earnings announcement on May 2, markets closed at $124.72, a decline of 0.17% from the previous day s price of $124.94. To summarize, C hevron has been unable to grow production. Although the company has been increasing dividend every quarter, it s critical to C hevron that its investments start paying out. To know more about CVX s major capital projects, read the next part of the series. Why Chevron s capital projects are crucial for production growth Major capital projects C hevron expects to invest $40 billion on capex this year, of which, 90% will be spent on its upstream business and the remainder on its downstream business. This was the case in 2013 as well when C hevron invested $41.9 billion and expects to spend approximately the same amount through 2016. Majority of the amount would be invested in Australia, Asia, and North America, while the remainder will go toward projects in Europe and Latin America. Countries it would be focusing on this year include Australia, the U.S. Gulf of Mexico, Kazakhstan, and Angola.
Over the next five years, 50 projects of more than $250 million each are scheduled to begin and 16 of those will have an investment exceeding $1 billion. While C hevron noted that capital expenditures, which totaled $41.9 billion in 2013, have peaked, they are not expected to come down in the near term. As mentioned above, the company foresees flattening investments at a rate of about $40 billion through 2016. C learly, C hevron has a huge pipeline of massive investments, stated to increase production by 27%, to 3.3 MBOE/D (million barrels of oil equivalent per day) by 2017. CVX divides its growth projects into three segments Deepwater-focused growth projects, LNG-focused growth projects in Australia, and shale resources focused growth projects in the Permian Basin in the U.S. and the Vaca Muerta Shale in Argentina. The Deepwater-focused projects include the Jack/St.Malo project, which is scheduled to start in 4Q14, as well as the Big Foot oil export pipeline, which is stated to begin by mid-2015. The LNG segment has two major projects both in Australia the Gorgon project, which is about 80% complete and the Wheatstone project, which is about 33% complete. Both the Gorgon and the Wheatstone projects combined, have a capacity of 400,000 MBOE/D and are critical to C hevron s future growth plans. They driving on the back of massive amounts of capex of approximately $54 billion and $29 billion, respectively. Chevron is also progressing on its shale resources development. It has drilled over 120 wells in the Permian in the year so far and is also expanding exploration acreage in the Vaca Muerta Shale in Argentina. In the earnings report, C VX stated, We continue to advance our key development projects. and we are anticipating production growth in 2015 and beyond as a result of these investments. Significant progress has been made on the construction of our Gorgon and Wheatstone projects in Australia. Our Jack/St. Malo and Big Foot projects in the Gulf of Mexico are also progressing, with first production planned for late 2014 and mid-2015, respectively.
Most of these projects are stated to begin production by the end of 2014, the anticipated growth as a result is critical to C hevron s balance sheet. C hevron is anticipating 20% production growth, by 2017 which implies a production increase of 3.1 million barrels of oil-equivalent. This could easily translate into earnings of $25 billion to $30 billion by 2017. So, a lot depends on these projects coming online and contributing to production growth. Chevron is a part of the Energy Select Sector SPDR Fund (XLE), Vanguard Energy ETF (VDE), SPDR S& P Oil & Gas Exploration & Production ETF (XOP), and ishares U.S. Energy ETF (IYE). C hevron s business is largely dependent on crude oil prices. Read the following part of the series to know how crude prices impact its earnings. Why lower crude prices negatively affected Chevron s earnings Commodity prices affect upstream revenues Upstream energy companies (also referred to as exploration and production or E& P companies), such as C hevron C orporation (C VX), produce hydrocarbons like crude oil, natural gas liquids, and natural gas. So the revenues for E& Ps are a direct function of how much oil and gas they produce as well as the prices of oil and gas. So, commodity prices affect upstream companies revenues and ultimately their earnings and stock price (valuation), as well as ETFs that contain upstream companies, such as the Energy Select Sector SPDR (XLE), the SPDR S& P Oil & Gas Exploration & P roduction ETF (XOP), the VanEck Vectors Unconventional Oil & Gas ETF (FRAK), and the ishares US Oil & Gas Exploration & Production ETF (IEO). In the previous section we discussed how earnings for C hevron for this quarter (ended March 31), were down due to low production volumes. Another reason why the earnings were down were the crude oil prices they were lower than the prior quarter causing lower crude realizations. Crude oil prices background
Crude oil prices are based on two benchmarks West Texas Intermediate (or WTI) and Brent crude. WTI represents the price oil producers receive in the U.S. and Brent represents the prices received internationally. C hevron s crude oil prices are based on Brent. This means that the majority of C hevron s crude production is priced based on the Brent benchmark. Chevron s average sales prices for crude oil and natural gas liquids were $91 per barrel in the U.S. and $99 per barrel internationally in the first quarter. In the same period, in the U.S., the WTI prices averaged $100 per barrel, whereas internationally, Brent prices averaged $108. C ompared to the previous quarter, Brent prices were down from $109 per barrel, but the average WTI prices were actually higher than last quarter s $96 per barrel. C ompared to the previous year, the crude oil sales prices for Chevron were down by 3% in the U.S. and 2.9% internationally. C hevron also gains from international exposure and the Brent price benchmarks, as Brent prices have remained higher than WTI over the past few months, especially since mid-april. One reason may be the escalating tension between Russia and Ukraine helped to boost Brent crude oil prices, as Russia is a major oil exporter, and geopolitical events outside the U.S. are more apt to affect Brent crude prices than WTI prices. Although Brent prices are lower than the previous quarter, they have been steadily increasing as can be seen from the graph above. During first quarter 2014, Brent averaged $108 per barrel compared to the previous quarter, this was ~$1 decline, as prices averaged $109 per barrel in the previous quarter. For 2014, the U.S. Energy Information Administration (or EIA), in its short-term energy outlook projects Brent Crude prices to average $106 per barrel in 2014, and $102 per barrel in 2015, and the spread between Brent and crude prices to average $10 per barrel in 2014 and $11 per barrel in 2015. Currently, the WTI-Brent spread is $8.89 per barrel (as of May 2, 2014). To know more about the WTI- Brent spread, read Why the WTI-Brent spread is $4 per barrel wider since mid-april.