Oil prices are in a terrible funk thanks to the demand drop-off related to efforts to slow the spread of COVID-19. Since oil is a commodity, there's nothing that drillers can do about that other than make sure they are prepared to deal with the headwinds. Integrated giant Chevron (NYSE:CVX) is one of the best positioned to muddle through the downturn.
This oil market is really bad
To give you a picture of just how difficult things are today for energy companies, consider that a key U.S. oil benchmark price fell below zero earlier in the year. Think about that: Oil companies were, effectively, paying customers to take oil. There were technical reasons for the price drop, and it was brief, but oil has remained painfully low throughout 2020. Some once-proud companies have succumbed to bankruptcy, like U.S. onshore pioneer Chesapeake Energy. Other companies have slashed their dividends, announcing that they have basically given up on oil and are looking to shift toward clean energy. BP is probably the biggest name here, having announced that it believes that peak oil demand is already behind us.
It's worth noting, however, that both BP and Chesapeake Energy have had particularly heavy debt loads. That's important, because excessive leverage limits financial flexibility when times get tough. Chesapeake didn't seek bankruptcy court protections because it was looking for something fun to do; it had no choice, because it couldn't afford to pay its creditors. And BP highlighted the need to free up cash to invest in what it believes will be the future of global energy, but the real reason it cut its dividend was that it had so much debt it couldn't pay its dividend and reinvest in itself at the same time. Total is going down a similar path, though it hasn't resorted to a dividend cut.
That brings the discussion to Chevron. With third-quarter earnings on the horizon (Oct. 30), it's worth taking a look at just how strong this global giant really is.
A rock in a storm
For starters, Chevron's second-quarter financial debt-to-equity ratio was an impressive 0.20. That's lower than those of any of its direct peers, with only ExxonMobil coming close at 0.36. BP, for reference, had a financial debt-to equity-ratio of 0.82. In fact, Chevron's current goal is to guard its balance sheet so it is resilient to oil prices in the $30-per-barrel range. (Oil prices are currently near $40-per-barrel.)
There's more to this story than just carrying a low level of debt, though. Like its peers, Chevron has been cutting back. There are obvious moves, like suspending its share repurchase program. But there are also bigger-picture changes, like reducing operating expenses by $1 billion and trimming the 2020 capital budget by $6 billion. Notably, the oil company's second-half capital expenditure run rate is 40% below what it had budgeted at the start of 2020. It is clearly working hard to keep costs in check. Notably, even before the cuts, it already had one of the most modest capital spending plans within its peer group.
Many of the cutbacks are coming from short-cycle investments. These are projects like onshore U.S. oil drilling that can be quickly ramped up and down depending on the market environment. So if oil starts to pick up again, Chevron can relatively easily start to bring these capital investments back online. Yes, it is making permanent changes, but it is also trying to retain as much optionality as it can. That effort will position it well today, but also for the future.
Another ugly quarter
Third-quarter earnings are likely to be pretty dismal reading for Chevron shareholders. However, it's vital to go in understanding that this oil giant is particularly well positioned to deal with the ongoing headwinds. There's no telling what happens from here, of course, as much depends on the path of the global pandemic. But if you are looking for bargains in the oil patch, it would behoove you to stick with financially strong players. And on that score, Chevron, and its hefty 7% dividend yield, are at the head of the pack.