Chevron's Expected Recovery Hits a Bump in the Road

After posting a relatively decent earnings report in the prior quarter, Chevron's (CVX 0.75%) investors were anticipating a bit of a breakout this past quarter. After all, this was the same quarter where we saw OPEC's decision to cut production and drilling activity in the U.S. has started to pick back up. 

This wasn't necessarily the case, though. Thanks to a few income hampering events -- some expected, some not -- Chevron's earnings were rather muted. Here's a quick rundown of Chevron's results, what happened in the quarter, and what investors can expect in 2017.

Image source: Getty Images.

Chevron's results: The raw numbers

Data source: Chevron earnings release. *In millions, except per-share data. 

Chevron put together a pretty strong prior quarter considering the prices for oil and gas at the time. In fact, last quarter was the first time where we really got to see the results of management's efforts to cut costs. This quarter was a continuation of that work to a certain degree, as evidenced by its U.S. upstream business segment posting an earnings gain for the first time since the fourth quarter of 2014.

Also, keep in mind that the average realized natural gas price for its international upstream was lower this past quarter than in the prior quarter. While Chevron is heavily levered to oil production as a percentage of its overall mix, more than 80% of its natural gas production comes from overseas. So the fact that its international upstream segment was able to post earnings despite rather flat price realizations is a sign that things are improving for the production side of the business.

Those gains were offset, though, by some expected weakness in its downstream business coupled with $872 million in corporate charges compared to $238 million in charges this time last year. 

Data source: Chevron earnings release. Author's chart.

Cash generation continues to be a struggle for Chevron. While it was able to almost cover all of its capital spending for the quarter with operational cash flow, it still came up short in meeting its dividend payments and resorted to issuing $500 million in debt and another $600 million in asset sales. For 2016, the company was $15.5 billion short in meeting its cash flow needs.

What happened with Chevron this past quarter?

• Overall upstream production in the quarter increased to 2.67 million barrels of oil equivalent per day (mmboe/d) from 2.51 mmboe/d in the prior quarter. Project ramp-ups at Gorgon, Angola LNG, and some offshore production sites, coupled with the end of turnaround work at several other major capital projects, were responsible for the gains. Management did note that, though, that it is still seeing some issues related to civil unrest in Nigeria, which negatively impacted total volumes.
• Large turnaround work at the Richmond, California, facility reduced total refining volumes in the U.S. by 21%. That turnaround work was one of the biggest reasons that U.S. downstream earnings were zero for the quarter. When refineries aren't running at high utilization rates, they rarely make money. So this poor performance shouldn't be surprising. Lower refining margins and some tax charges also contributed to the lower earnings in this segment. 
• Total asset sales for 2016 was $2.8 billion. At the end of the third quarter, management had stated that it was confident it could meet its asset sales target of $5 billion to $10 billion, but now that target date has been pushed back to the end of the year. This probably makes more sense as oil and gas asset value has been on the rise and Chevron could likely get a better price if it can hold off from selling now.
• Management is now guiding for 4%-9% production growth in 2017 before asset sales. The continued ramp-up of Gorgon LNG and other major capital projects, the restart of its work in the partitioned zone between Saudi Arabia and Kuwait, and increased shale drilling in the Permian Basin are expected to lead the charge in growth for the coming year.
• Total capital spending for 2017 is now expected to be $19.8 billion, which makes for the fourth year in a row of capital spending cuts. 

What management had to say

On top of announcing its capital budget for the coming year, Chevron's management also guided for capital spending for the next four years to come in roughly between $17 billion and $22 billion. On the conference call, one analyst pointed out that more than $2 billion is still dedicated to two major projects -- Gorgon and Wheatstone LNG -- that are expected to be complete by 2018. So when asked what the company plans to do with that spending in the coming years, CEO John Watson pointed out some of the opportunities in today's price environment, with a big focus on shale:

I would expect that we would see an increase in unconventional spending. We've talked about ramping up the Permian, and I think that'll be the case. We're budgeting about $2 billion this year, but you could easily see another $1 billion there. We have very little activity in the Marcellus now. I would -- we've gotten very efficient there, but we would expect better market conditions and offtake capability there. We've made good progress in the Duvernay, Argentina. So just in the shale and tight area, you could see some increases. But again, that's short-cycle, high-return activity.

Now we do have some opportunities in the portfolio that if we continue to make good progress on concepts and sort of delineation drilling, things like Anchor and Tigris, and we've highlighted Rosebank and a few others. So we have a good queue of projects, but we need to make sure that those have kind of the right economics associated with them, that -- but all of that can comfortably fit in the range that we've talked about. But I'll just say that if we're at $50 to $55, you should expect spending to go down next year.

10-second takeaway

No cyclical recovery is going to go in a straight line, and this past quarter was a bit of a blip on that recovery trend. If we we take out some of the expected items like turnaround work at Richmond, though, it looks as though the company is on the right track. As always, the concern for Chevron is to get to cash flow breakeven. For the past two years now, the company has been saying that this is the year we can expect to see operational cash flow to cover all its spending and dividend payments. Investors should watch to see that this spending gap can finally be bridged in 2017.  If it can, then Chevron will be well on the path to putting this oil downturn behind it.