The timing of the announcement couldn't have been any unluckier. In early March, before the novel coronavirus outbreak turned into a global pandemic and OPEC opted to keep pumping oil at its previous pace, crude prices were tepid but at least stable. Chevron (CVX 2.21%) had every reason to believe it would be able to fund up to $80 billion worth of dividends the company suggested were in store over the course of the coming five years. Since then, the price of West Texas Intermediate (WTI) oil has fallen by more than $23 per barrel, to roughly $24. The price of Brent crude has slipped to a value of around $33. It's unlikely CEO Michael Wirth saw the world change as it has in just the past three weeks.
To his and the company's credit, Wirth is backing off. Capital spending plans for this year have been reduced by 20% to reflect the fallout from the coronavirus crisis, and Chevron's stock buyback activities have been suspended. Still, he made clear in an interview with CNBC on Tuesday "our dividend is our number one priority and it's very secure."
But, that doesn't necessarily mean the company can afford to pay it.
Number-crunching
The oil business is a curious one. Demand for its end products is relatively consistent. But its (perceived) supply can change rapidly when most of what's produced is also immediately consumed, driving big price swings.Exacerbating this volatility is hedging of -- and speculating on -- these price changes.
The cost of extracting oil from the ground is also at least broadly predictable per location, even if not consistent from one drilling project to another.
At $24 per barrel for WTI, though, and $33 for a barrel of Brent, crunching such numbers is almost moot.
Image source: Getty Images.
Pinning down Chevron's exact production cost for a barrel of oil, or its equivalent, can be tough. It's not just a driller. The company also operates downstream businesses like refining and distribution, and it's a chemical company to boot. Both arms help reduce the fiscal volatility of drilling and fracking for oil or gas.
The oil drilling business is also reasonably scalable. Chevron can lower its operational expenses by mothballing operations which cost more to run, and Wirth has already explained the company is going to cut some expenses immediately. That may further pare back the per-barrel cost figure.
Still, upstream production is the company's breadwinner, accounting for nearly 90% of Chevron's 2019 operating earnings, mirroring 2018's results. This is the arm that will be most heavily impacted by the sharp reduction in crude's value, since total operational spending is more closely tethered to upstream operating earnings, production, and oil prices than any other measure.
Image Source: Chevron Corporation. Image by Author.
The math: The company produced 3.08 million barrels of oil or oil-equivalent per day, or roughly 280 million barrels last quarter.That figure divided by right at $6 billion in operating expenses -- excluding administrative costs -- translates into a number right around $21.40 per barrel... a number which, by the way, jibes with previous quarters as well as costs its peers and rivals are facing. Energy consulting and oil intelligence outfit Rystad reckons the breakeven oil for fields already in production is around $26 per barrel. The United States' Energy Information Administration pegged 2018's operating breakeven point at $24 per barrel.While Chevron has generally proven to be above average in terms of cost control, even for the best-managed names oil prices are dancing uncomfortably close with its breakeven prices, which still don't account for items like depreciation, impairments, and expenditures on exploration and well development.
The red flags are waving beyond the most basic of cost concerns too. Chevron's total breakeven point for its upstream business, according to its own calculation made last year, is around $51 per barrel. Separately but similarly, in February's investor presentation the company touted 2018's earnings per barrel of $14.45, but Brent crude's average price in 2018 was a much healthier $71 per barrel.
Its chemical and downstream businesses aren't apt to offset much of any weakness either, as tepid oil prices can also work against pricing power in those arenas.
Simply put, even without knowing the exact specifics, we know enough to know prices are nowhere near the ballpark they need to be to make drilling and production a profitable venture.
In line with peers, but to no avail
For perspective, Rystad believes Occidental Petroleum's production costs amount to less than $30 per barrel. Rystad also estimates ExxonMobil's Permian Basin operations in New Mexico properties are still profitable even when crude is trading at just under $27 per barrel. That bodes well for Chevron, which has particularly focused on its Permian operations in Texas and New Mexico of late, where its operational costs are also unusually low.
In other words, Chevron's apparent costs aren't out of line with the other major names in the business, and operations that sport a higher-cost profile can clearly be shut down.
The comparison means little given the current circumstances though. Chevron's strong fourth-quarter numbers and the expenditure/dividend plans revealed in early March were based on Q4's average U.S. sales price of $47 per barrel of crude, and $57 per barrel internationally. Prices are roughly half that level now though, and gyrating at values around just the company's likely operational costs per barrel. That leaves no room for error when there was little to begin with. The trailing-12-month payout of $4.76 per share already consumes the bulk of operating earnings. That figure was a reasonably healthy $6.27 per share in 2019, but may not hold anywhere near that figure this year.
Chevron's got $5.7 billion in cash and roughly twice that amount in short-term receivables on its balance sheet to help fund the dividend, for the record, so the dividend may indeed be "safe." That doesn't mean paying it won't take a toll somehow, somewhere if crude's price weakness persists.
The 2015 oil meltdown serves as an example of what can happen when a dividend is arguably over-prioritized. Chevron maintained its dividend in the midst of that nightmare, but long-term debt grew from less than $28 billion at the end of 2014 to $33.6 billion by the end of 2015, while its cash and near-term receivables fell by $5.6 billion. Its cash balance fell again in 2016, and debt grew again as well. Moving into this sort of fiscal scenario makes it trickier to invest in growth once oil prices recover, which in the end has the potential to limit future dividend growth.
In simplest terms, everything is a trade-off. Your job as an investor is just making sure the trade-offs are worth it for the long haul. This one may not be.
By the way, Occidental and a few other energy names have already decided to cut their dividends as a defensive measure. That's an important hint in itself.
