Chevron's (NYSE: CVX ) stock has had a tough last couple of months. Since mid-January, Chevron has dropped by nearly 9%. While many rightly see Chevron as a world class company with an excellent track record and a steady, growing dividend, I believe there is good reason for the selling.
The chart above shows us that while shares of all three U.S. 'big oil' companies have dropped year to date, Chevron has underperformed its peers overall. The reasons for this, in my opinion, are twofold: disappointing operational results from last quarter and also a sense among investors that Chevron has made some strategic errors over the last couple of years.
Passing on the shale
As most very large energy companies do, Chevron tends to focus its capital on large scale "mega-projects" that can move the needle for its earnings. Chevron's management has decided to spend its capital on two deepwater oil projects in the Gulf Of Mexico, two huge liquefied natural gas, or LNG, plant projects off the coast of Australia, and one LNG project off the coast of Angola.
To be clear, deepwater oil and international LNG will be a larger part of the world's energy mix in the future. But the most significant energy developments of the last decade have been in horizontal drilling for shale oil, in which Chevron has had only limited participation. If you don't believe that investors have taken notice, let me share with you an analyst comment from the last quarterly earnings call:
And I was also referring to the Permian obviously where you have got a huge acreage position. It just feels that if that was in the hands of an independent they'd be gung-ho after it, whereas it feels that perhaps due to corporate [capital expenditures] constraints you guys...are going a little bit slower.
Credit Suisse analyst Ed Westlake was referring to horizontal prospects in the Wolfcamp shale play, which is part of the Permian Basin. Despite being the second largest producer in this geography, Chevron has yet to meaningfully take advantage of horizontal drilling opportunities. Analysts believe this is because the company has huge capital commitments elsewhere. I believe this is affecting Chevron's share price right now.
Cost overruns on major projects
Chevron has staked its future production on a few mega-projects in either deepwater or LNG, both of which will become a big part of the company's production profile in the years to come. But these mega-projects have thus far had mixed success. While these projects are progressing in a timely fashion, the two Australian projects, named Gorgon and Wheatstone, have had very significant cost overruns.
The Gorgon project, for example, was originally expected to cost only $39 billion. But this figure has ballooned to an expected $54 billion thanks to rising Australian labor costs and currency exchange rates. In fact, Australia has the highest labor costs in the developed world when it comes to extracting oil and gas. That country's relative emphasis on a unionized workforce and 'green' regulation, compared to business-friendlier countries such as the United States, has undoubtedly contributed to the skyrocketing costs, too.
There's no doubt that Chevron is a world class company with some of the best scientists in the world. And, to be sure, this well diversified super-major is still a good, low-risk way to add energy exposure. However, the most revolutionary developments in fossil fuels over the past 10 years have been the advancements in shale drilling; and Chevron has not participated in the same magnitude as other big companies such as ConocoPhillips or Statoil.
When we consider this, and the fact that cost overruns will surely take a bite out of the profitability of Chevron's mega-projects, it's not too hard to see why this stock has underperformed its 'big oil' peers.
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