A lot has occurred in the crude market since February that have made many investors believe the worst is over. Not only is demand growing by around 1.4 million barrels per day, but supply in various parts of the world have also retreated sharply. Given the improving state of the market, let's analyze three green shoots in the sector and how they're bullish for Chevron (CVX 2.07%).
U.S. supply is declining
The low crude prices have caused U.S. production to decline from 9.7 million barrels per day and a strong upward trend to 8.6 million barrels per day and a nice downward slope. U.S. production is falling by around 100,000 barrels a day per month and will probably continue to decline for a few more months because of the lag between rig drilling and production from wells. The Energy Information Administration expects U.S. production to decline to a range of 8.1 million to 8.2 million barrels per day before it bottoms out. If that occurs, U.S. production will have fallen 1.6 million barrels per day from peak to trough, or nearly as much as the entire supply glut was at its worst. With the U.S. rig count still falling, there is potential for a steeper-than-expected production decline than EIA expects if the drilled but uncompleted wells don't offset the difference.
Meanwhile, Chevron's production is expected to increase. Because many of Chevron's pre-productive projects that will become productive over the next two years, the company's total production is expected to rise from 2.622 million barrels of oil equivalent per day to 2.9 million or higher over the next few years when excluding potential asset sales. The increased production will increase Chevron's cash flows and profits, supporting the company's dividend and valuation.
The factors for shale growth are no longer as favorable
Given that the decline in U.S. shale production has accounted for the majority of the drop in U.S. production, it would seem that shale is the swing producer at the current price levels, making how quickly shale production rebounds the key factor in deciding the fate of this energy rally. To that end, several of the factors that promoted the rise of shale have reversed. First, the low U.S. unemployment rate and tight job market make hiring back laid-off shale workers harder. This means shale drillers will have to train new workers who won't be as efficient as the old workers. The lower efficiency increases shale's costs and slows shale production growth.
Second, the market for shale financing has tightened. Even with the 80% jump in crude prices, bankers are cutting credit lines. Recently, banks cut Bonanza Creek Energy (CIVI 2.81%)'s credit line to $200 million from the previous $475 million, causing the company to have a shortfall of $88 million. A similar event could occur to other companies in the same shape. The lack of credit will further hamper production growth.
Because it has a strong balance sheet, Chevron's capex budget isn't dependent on the whims of bankers. For the next few years, Chevron plans to continue maintaining its shale investment spend or to even increase it. The continued steady to increasing shale spend will help Chevron's operations become more efficient and realize higher margins.
Geopolitical events are starting to take a bite out of production
In the early days of the crash, many assumed that geopolitical disturbances would cause supply to fall and oil prices to rally back. Aside from a series of isolated events, serious geopolitical events haven't really occurred until recently. Various governments around the world were able to keep the disturbances low by using their borrowing capacity. With those governments now at the brink of their financial capacity and various non-state actors having lost patience with the status quo, many want change, and political disturbances have increased in frequency. Nigerian militants are attacking the country's infrastructure, causing production to fall significantly from the original level of 2.2 million BOE per day. There is potential for rebellion in Venezuela that could cause a similar shortfall, and there are disturbances in Iraq and Libya that won't go away for a long time. Any of the events can spread to other countries and cause more disruption.
Given that Chevron doesn't have much production in Venezuela, and its production in Nigeria accounts for only 4.2% of its daily average production, Chevron's earnings will probably benefit from the disturbances because of the resulting rise in oil prices.
The three green shoots are bullish for Chevron. With the factors continuing, Brent has a greater probability of reaching $52 per barrel or higher and staying there. If that occurs, Chevron's annual dividend of $4.28 per share is sustainable and might increase. With the higher dividend comes a sounder valuation and potential for further upside.