Oil and gas giant Chevron (NYSE:CVX) recently raised its price assumption for oil from $79 a barrel to $110 a barrel even as it lowered its production outlook to 3.1 million barrels of oil equivalent per day (MBOED) from 3.3 MBOED in 2017. The company has based its oil price assumption on the average over the past three years. However, given the outlook for oil prices, the projection from Chevron is probably too bullish.
Chevron's oil price outlook
During a meeting with analysts in New York earlier this month, Chevron said that as a result of high price of oil it has modeled its projections based on Brent crude oil price of $110 a barrel, up from $79 a barrel. Chevron is not the only major oil and gas company to assume a Brent crude oil price level well above the $100 a barrel mark. Rival ExxonMobil (NYSE:XOM) has also used a similar level. Exxon's price of $109 a barrel is based on 2013 average prices. BP Plc (NYSE:BP) in a recent investor meeting based its projection on oil price assumption of $100 a barrel, which seems more realistic.
Even though Chevron raised its oil price projection, the company cut its production outlook due to project delays and asset sales. Exxon also lowered its production outlook recently.
What's wrong with this target?
Chevron's and Exxon's price assumptions might be too bullish. The $110 a barrel price assumed by Chevron is well above the price level implied by the futures market.
According to the U.S. Energy Information Administration (EIA), Brent crude oil spot prices averaged between $108 a barrel and $112 a barrel for the eighth straight month in February. However, the EIA expects price of Brent crude oil to weaken due to growth in non-OPEC supply, which is expected to exceed growth in world consumption. An increase in non-OPEC supply growth has also been projected by the Paris-based International Energy Agency (IEA).
The IEA in its Oil Market Report (OMR) released last week noted that non-OPEC supplies are expected to increase by 1.7 million barrels per day after rising by 1.3 million barrels per day in 2013. The growth, not surprisingly, will be driven by the U.S. and Canada. The IEA expects the pressure on global oil markets to ease due to a surge in supply from non-OPEC producer as well as from Iraq, which is part of OPEC.
According to the agency, Iraq's oil production increased by 530,000 barrels per day in February, resulting in OPEC crude supplies in February crossing the 30 million barrels per day mark for the first time in five months.
The supply increases come at a time when China, the world's second largest consumer of oil, is seeing a slowdown. While the global macroeconomic environment has certainly improved, a slowdown in China will definitely have a negative impact on oil demand, at least in the near term. Other emerging markets such as India and Brazil have also been struggling. Both countries also have very high current account and fiscal deficits, which will eventually force them to reduce fuel subsidies. Reduced subsidies will lower oil demand in both countries.
Despite the slowdown in some emerging markets, overall long-term demand for oil is solid. However, the robust demand is expected to be matched by significant supply growth. Given this factor, Chevron's oil price projection certainly looks far too optimistic. The U.S. EIA expects Brent crude oil prices to average $105 a barrel in 2014 and $101 a barrel in 2015. WTI, which trades at a discount to Brent crude, is expected to average $95 a barrel in 2014 and $90 a barrel in 2015. The EIA projection is also in-line with what most analysts expect.
If Brent crude oil prices average between $100 a barrel and $105 a barrel in the longer-term, it will certainly have an impact on Chevron's bottom-line, given that the company's projections are based on a price of $110 a barrel. This combined with weaker expectations for production growth could hurt Chevron's operating cash flows and its plans to reduce net debt.