Very rarely do you see a company as large as Chevron (NYSE:CVX) post 30% returns in a single year. 2016 was a pretty unique time for the oil and gas industry, though. After oil prices bottomed out in January of last year, there are lots of signs that the industry is looking much healthier. On top of that, some of the initiatives Chevron's management undertook over the past couple of years finally started to pay off, resulting in a fantastic stock price performance.
Let's take a look at the details of why Chevron's 2016 was the best of the integrated oil and gas companies, and whether investors can expect strong gains again this coming year.
Higher prices + lower costs = better results
With large integrated oil companies, it's easy to fall into the trap of thinking that they are relatively similar and will benefit equally from certain catalysts. That isn't necessarily the case, though. Of the big five integrated oil and gas companies, Chevron is most reliant on upstream production for profits, particularly oil.
|Company||Upstream Assets as % of Total Capital Employed||Liquids Production as % of Total Production|
|Royal Dutch Shell (NYSE:RDS-A) (NYSE:RDS-B)||76%||52%|
Shares of Chevron tend to be much more sensitive to the price of oil than the rest of the bunch. In 2016, this was a decent position to be in, as crude oil prices improved throughout the year and are now at a rather reasonable range of $50-$60 per barrel. As a result, shares of Chevron posted the best gains among the integrated majors.
What is probably more important than the ups and downs of oil prices, though, are the steps that Chevron has taken over the past couple of years to cut both operational and capital costs. Since 2014, Chevron has cut close to $2 billion out of its quarterly operations and SG&A expenses, as well as lowered its quarterly spending on exploration and development by about half.
Until recently, we didn't really get a decent gauge of how these cost savings were impacting the bottom line because oil and gas prices were still falling. However, in the third quarter, we got the best comparison to date. Even though price realizations for both oil and gas in the third quarter of 2016 were 10% lower than the same quarter in 2015, Chevron's upstream earnings results improved from $59 million in Q3 2015 to $464 million in Q3 2016.
All of this cost-cutting and scaled back capital spending is geared toward getting back to cash flow break-even in 2017. This has been management's goal for a couple of years, and that time frame pretty much lines up with the completion of its two largest capital projects: the Gorgon and Wheatstone LNG facilities in Australia. Once these come online, its capital spending budget is expected to decline even further and allow the company to fully fund both its capital budget and its dividend with operational cash flow, something that hasn't happened since 2012.
This year, those plans appear to be on track. Construction for two of the LNG process trains is complete at Gorgon, with the third slated to come online in the next few months. Likewise, Wheatstone's construction schedule is projecting full start-up in Q4 2017 to Q1 2018. After years of cost overruns and delays, getting these projects up and running will have a big impact on Chevron's bottom line, and it has certainly helped boost stock prices this past year.
Will the music keep playing?
Aside from the changes in oil prices that will likely have a large impact on how Wall Street views Chevron's stock, there isn't a whole lot of variability in Chevron's outlook. Most of the company's major capital projects are in development and have set completion dates, so production growth targets for the next few years are already in place.
The one place where we could see some extra upside is with the company's shale development in the U.S. Chevron has about 2 million acres in the Permian Basin, the most prolific and economical shale basin the U.S. Not only has the company been able to continually lower costs for better per-barrel profits, but current production rates from this part of the business are outpacing the high end of management's growth targets.
Granted, the 150,000 or so barrels per day from shale is a pretty small blip on Chevron's total oil and gas production of 2.5 million barrels per day. However, U.S. upstream production has been the ugly stain on its earnings for some time now. If the company could get better results in this segment, it would really help improve the overall earnings picture for the company.
What a Fool believes
Chevron has made a lot of difficult decisions over the past couple of years to preserve its balance sheet and deal with the crash of the oil and gas market. Those decisions started to pay off in 2016, though, as we started to see the impact of cost savings on the bottom line.
If oil prices were to remain around where they are today for the rest of 2017, then Chevron will likely see a decent uptick in earnings compared to last year, and it will certainly help restore confidence in the company's ability to keep paying its dividend.
With shares trading at a price to tangible book value of 1.5 times, Chevron's stock is still trading at a decent discount to its 10-year historical average valuation. That suggests we could continue to see more gains in 2017.