For the past few years, Chevron’s (NYSE: CVX) management had one goal: Be able to pay for its dividend with cash in 2017. Just about every decision management made during that time was centered around that goal, even if it was to the detriment of future investments. Well, thanks to some serious changes to its portfolio and cuts to operational expenses, the company was able to meet that goal by the skin of its teeth.
With 2018 well under way, I think it was fair to assume we would get a new strategic plan from Chevron that would align the company with the strategic plans of other Big Oil companies: significant production increases at much lower breakeven costs. Based on its most recent analyst meeting presentations, though, that doesn’t seem to be the case. Let’s take a look at what Chevron has in store for the next several years, why this plan seems to lack oompf, and some potential growth avenues that may be there if you read between the lines.
More of the same
Glancing at the most recent strategic plans across Big Oil firms, there is one common theme: All plan on growing production at rather high rates over the next few years. BP, Royal Dutch Shell, and ExxonMobil all intend to add 1 million barrels per day (BPD) to their existing product portfolios. At the same time, these companies are also making significant investments in downstream operations that should contribute heaps of consistent cash flows to offset the ups and downs of upstream commodity prices.
Most of these companies more or less move in tandem, but Chevron’s strategic plans seem to differ significantly from the rest of its peers. According to management, it intends to maintain low levels of capital spending ($18 billion to $20 billion annually) from 2018 to 2020. It appears that a larger focus for Chevron remains on lowering its costs and continuing to squeeze more out of assets currently producing. It estimates that it will grow production by 4%-7% annually between 2017’s numbers and 2020, which would equate to an additional 250,000-500,000 BPD of new production.
In the short run, focusing on costs and existing assets is a great way to juice returns. There is a trade-off, though. When you increase production levels at an already producing reservoir, you increase the depletion rate of those reservoirs and the production life of the reservoir. That means further down the road, production rates decline quickly and you need to invest heavily to replace that production.
At the same time, Chevron’s investments in downstream refining and petrochemical manufacturing seem quite modest compared to the rest. Part of the reason is that much of Chevron’s petrochemical capacity is held in a joint venture with Phillips 66 known as CP Chem, and capital spending for that venture doesn’t come directly out of Chevron’s cash capital investments. Still, Chevron has had a track record of selling downstream assets lately and intends to shed even more in the near future as its South Africa refinery is currently held for sale. There doesn’t appear to be a significant growth trajectory for this part of the business, especially compared to its peers.
The ace in the hole
If investors are a little discouraged with this plan, there may be some solace in one part of the business that Chevron remains rather quiet about: shale. Sure, the company has been proudly touting its progress in the Permian Basin for a while now, and Permian production has exceeded every company estimate thus far. However, its Permian assets are just one portion of a rather extensive position in various shale basins across North America.
Chevron investor slide highlighting the progress it has made on improving well economics for its shale holdings in Canada, Argentina, and the Marcellus formation in the U.S.View photos
Chevron investor slide highlighting the progress it has made on improving well economics for its shale holdings in Canada, Argentina, and the Marcellus formation in the U.S.
The thing that stands out here more than anything else is the resource estimate. At 17.5 billion barrels of oil equivalent, it is a massive resource base that could fuel Chevron’s production for more than a decade. As it stands today, its shale resources represent more than one-quarter of the company’s total resource backlog. Also, Chevron has shown with its Permian holdings that it can deliver shale production relatively economically.
Probably the reason that Chevron isn’t shouting from the rooftop about these assets is that it is incredibly challenging to monetize them at this point. All of these regions are constrained when it comes to infrastructure, and Canadian shale gas formations like the Duvernay need another market to sell to other than the U.S. because, well, shale gas is already cheap there.
Chevron’s Duvernay and less mentioned Horn River shale gas holdings are the resource base that underpins Chevron’s plans for its massive Kitimat LNG facility, a project management had previously touted but has been strangely quiet about over the past few years. These two assets will likely get developed concurrently, but that probably won’t happen in the two to three year window that its current strategic plan covers.
What a Fool believes
For an investor looking at Chevron’s strategic plan over the next few years, there isn’t a whole lot to get excited about. Management is playing it safe with a plan that remains focused on cutting costs, bolstering the balance sheet, and keeping a conservative capital plan. That isn’t necessarily a bad thing, but it does stand out in contrast to its peers that appear to be able to achieve those first two things while ramping up spending. Personally, the most discouraging aspect of this plan is the lack of downstream investment. Chevron’s business already had the highest exposure to production, and it seems to be doubling down on that position instead of rounding out its integrated business model.
Still, there are some longer tail parts of the business for which buy and hold investors should be excited. Chevron’s shale business could easily become one of its biggest profit engines in the 2020s once it is able to develop the infrastructure necessary to monetize these assets.
For now, investors are likely better off looking at some of its peers. It’s going to take a while for Chevron to put a plan together to deliver on its shale assets, and the plans in place at others look like they will deliver superior returns until then.