Why Chevron's Dark Clouds Are Unlikely to Lift in the Near Future

These are tough times for Chevron (NYSE: CVX  ) , which recently released a preliminary fourth-quarter update. It's no secret that integrated majors such as Chevron and ExxonMobil (NYSE: XOM  )  are seeing their profits walloped due to extremely weak downstream conditions.

At the same time, investor patience may be running out. After all, these integrated giants maintain huge upstream exploration and production businesses as well, so there's a certain expectation from investors for management to keep overall profits afloat.

That hasn't happened yet, and Chevron's interim fourth-quarter update only reinforced the idea that difficult conditions will persist for some time. Fortunately, there are some additional factors that could shed a more positive light on the quarter.  

Chevron's fourth quarter likely to underwhelm
Chevron will release its fourth-quarter and full-year earnings on January 31. And, like many integrated oil majors, it's dealing with a tough operating environment that will make the quarter a difficult one. This is what caused its past results to land on the market with a thud, as its profit fell 5% in the three-month period and 13% over the first nine months of 2013. ExxonMobil's results followed suit throughout 2013, as its net earnings collapsed 31% over the first nine months.

Specifically, extremely challenging refining conditions are what caused Chevron's downstream profitability to suffer mightily. Spreads shrank throughout the year, which brought down margins across the refining industry.

For evidence of this, look no further than recent results from major refiners themselves. Major refiner Tesoro Corp. (NYSE: TSO  ) saw its third-quarter net income collapse by 63%. Tesoro's third-quarter earnings reflected the benefit of a sizable asset sale, so excluding that, its results look even uglier. Tesoro cited the weak margin environment across all of its geographic regions as the primary culprit for its poor performance.

Thankfully, Chevron sees the pressures on its downstream segment abating somewhat, at least through the first two months of the fourth quarter. Volumes are also looking pretty good. Chevron expects only a modest drop in international refinery crude-import volumes.

Meanwhile, volumes in the United States are expected to increase, reflecting the absence of planned maintenance activity at the company's California facility. In all, Chevron expects fourth-quarter results to be comparable with those from the third quarter.

Upstream margins appear resilient through the first two months of the final quarter. Average pricing realizations for both U.S. and international upstream activities are about where they were during the fourth quarter of 2012. On the downstream side, market indicators are fairly promising. Prices per barrel are down in the fourth quarter year over year but don't appear to have collapsed.

Additional headwinds make Chevron's future cloudy
Skepticism over Chevron's upcoming year is further fueled by the fact that it's cutting capital expenditures in 2014. The company's capital and exploratory investment program will total $39.8 billion in the upcoming year, down $2 billion from 2013 spending levels. When explaining Chevron's 2014 exploratory budget, chairman and CEO John Watson stated that 2013 likely represented a peak year of investment for the company.

Chevron will keep a disciplined focus in the upcoming year to create value for its shareholders. While a strict investment strategy is important to keep costs from getting out of control, it will nevertheless be difficult to produce higher profits, since exploration and discovery are key to locating promising opportunities.

Expect modest progress when Chevron reports
Chevron's fourth-quarter and full-year earnings report will likely show steady, but unspectacular, results. While profits are likely to level off on a quarter-to-quarter basis, Chevron will still probably post significantly lower net income year-over-year. And, due to a lower level of spending in 2014, pressure is on management to produce results. Investors will have to decide if they believe management is up to the challenge.

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