Chevron (NYSE: CVX ) is reportedly considering a sale of its entire U.S. midstream business -- infrastructure needed to store and transport crude oil. According to a report on Bloomberg, reliable sources with inside knowledge on the matter say that the oil major wants to seize the rising demand for midstream infrastructure in order to raise cash for oil and gas exploration, which is getting more expensive relative to previous years.
Although Chevron is yet to confirm anything, the potential impact of a midstream divestment in the current market could significantly lift the oil major's growth trajectory. Does this signal an opportunity to buy Chevron's stock before the upside potential is priced into its shares?
Soaring demand for midstream infrastructure guarantees great price
As I have pointed out before in previous articles, there is a great mismatch between the volumes of oil and natural gas being produced domestically and the infrastructure needed to store and transport it. Consequently, this deficit is leading to a lot of wastage, with 2013 reports putting the amount of Bakken natural gas flared (burnt at the well) at $100 million each month.
The gaping demand for midstream infrastructure has prompted midstream companies to not only upscale the construction of transport and storage infrastructure, but to also seek deals more aggressively in order to increase their asset holdings faster than the overall market. Data compiled by Bloomberg shows that acquisition deals in the midstream segment increased in 2013 even as deals in other segments -- upstream and downstream -- in the energy sector slipped.
Midstream companies are currently flush with cash. Their yields for debt and equity instruments are exceptionally high, with the majority of players, including Enterprise Products Partners (NYSE: EPD ) , offering yields above 4%. According to Jefferies Group, buyers of midstream infrastructure raised $61 billion in public debt and equity markets in 2013, up from $49 billion in 2012. This signals a huge thirst for deals. The thirst for deals means that Chevron will be able to get great prices for its midstream assets -- of course this is predicated on whether it pushes forward with the speculated sale.
Windfall inflows will sustain wider strategy
If Chevron divests its midstream assets, it will be able to secure windfall cash inflows. On so many levels, this will sustain its wider strategy and reward long-term shareholders significantly.
As is, the cost of producing oil is rising. According to Chevron's 10-K filed with the SEC, the average cost to pump a barrel of oil, as well as the equivalent in natural gas, increased 10.6% in 2010 to $17.10 a barrel. Higher costs reduce the incentive to spend more on capital expenditures as it reduces profit margins. Worse still, costs are increasing disproportionately relative to U.S. oil prices, which in exception to the recent rally have been relatively low all through. This low-margin environment, signaled by the slipping profits of major oil companies, threatens to compromise Chevron's wider strategy, which is increasing capital expenditures in order to tap into more reserves and consequently make more money.
Already, the low profit margin environment has taken its toll. Chevron expects to spend an estimated $40 billion in capital expenditures in 2014, down from $42 billion in 2013. ExxonMobil (NYSE: XOM ) too has been affected by the low profit margin environment. ExxonMobil's recent SEC filing shows that it expects to spend around $37 billion in capital expenditures this year, down from $42.5 billion in 2013.
Although Chevron's expected slowdown in capital expenditure is not a good sign, it is not a sufficient reason for panic. If anything, the oil major's capital expenditure is high on historical levels. Between 2008 and 2011, Chevron's capital expenditures averaged $24 billion, later jumping to $34 billion in 2012. Thereby, the projected $40 billion for this year, though lower than last year, is still commendable.
If the speculated asset sale goes through, Chevron will be able to erase the lingering fears of lower capital expenditures. This is because a huge windfall will present a two-fold benefit.
On one hand, a huge windfall will provide the extra cash needed to accelerate exploration in profitable areas, in effect preserving Chevron's current cash reserves. The $54 billion Gorgon project and the $29 billion Wheatstone project, both in Australia, could greatly benefit from accelerated spending. Gorgon, for instance, has been under construction for four years and is about 75% complete, with expectations that the first cargo from LNG will be shipped in early 2015. Accelerated spending thereby presents a great opportunity for Chevron.
On the other hand, the cash inflow from a potential asset sale will allow Chevron to maintain its attractiveness to equity investors, allowing it to easily tap into the equity market in the future. This is because an inflow of cash will allow Chevron to sustain its attractive dividend policy. Chevron has increased its dividends at an annual rate of 11% since 2004 and currently pays an annual dividend of $4 a share, translating into an attractive yield of 3.5%. A cash inflow from asset sales should allow Chevron to increase its dividend and the consequent yield even more, all along preserving existing cash flows. This improves the long-term picture as it makes Chevron more attractive, allowing it to easily raise capital needed for exploration in the public equity market.
How to profit from increased oil and gas spending
Imagine a company that rents a very specific and valuable piece of machinery for $41,000... per hour (that's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click HERE to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable LANDSLIDE of profits!