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There is a changing dynamic in the oil and gas industry, and Chevron CEO John Watson sees a move toward more flexible development as a way to handle it.
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Image source: Chevron investors presentation.
Even when comparing it to its Big Oil peers, Chevron (CVX +0.00%) has been taking it particularly hard on the chin in 2015. Part of that is self-inflicted, as the company has been stuck paying for large development projects while others have been able to wind down spending. This has led to some pretty weak earnings over the past few quarters.
What you need to remember, and something CEO John Watson would be quick to point out, is that you can't manage a company like Chevron on a quarter-to-quarter basis. Instead, you have to come up with a long-term plan that will be in the best interest of shareholders.
So, on the company's most recent conference call. Watson expounded a lot on how Chevron was planning on doing this. Here are five quotes from Chevron's CEO that paint a picture for what the company has planned over the next several years.
We're going to figure this out
Chevron made a promise to its investors during its analyst day presentation that it would be able to fully support its capital spending and its dividend payment with internally generated cash flow. Since then, the oil market hasn't exactly improved. Instead of reversing course, though, CEO John Watson is saying the company will figure out a way to make it happen:
Back in March, we committed to delivering free cash flow to cover the dividend in 2017. At the time, the futures market was envisioning $70 prices in 2017. Today, the futures market is lower, but our intent remains the same. Our goal is to balance our cash equation by completing projects under construction and reducing capital spend and operating expenses to levels consistent with the current market conditions. We will also continue to divest assets where we can obtain good value.
2017 is still more than a year away, and a lot can happen to the oil markets in that time frame. If the market follows its current trend, though, Chevron may find it needs to do a lot of budget cutting and several asset sales to make it happen.
Project logjam
Most of the integrated majors have been facing pressure from investors and analysts about the amount they were investing in new projects. As early as 2013, ExxonMobil (XOM +0.01%) said it would start to wind down its capital spending slightly as many of the projects under construction came online. ExxonMobil and a few others have been able to do this, but Chevron is a little behind since it still has some very capital-intense projects under development.
But now, explains Watson, Chevron has hit that peak spending point:
[W]e expect to see a significant inflection point over the next 2 years as a number of major capital projects move from being cash consumers to cash generators. Gorgon and Wheatstone are obvious contributors, but the list is long, starting with Lianzi in West Africa. Over the next several quarters, we expect a progression of start-ups that will include: Angola LNG, Mafumeira Sul, Moho Nord, Sonam, all these are in West Africa; Chuandongbei in China; the Bangka development in Indonesia; Alder in the North Sea; the Chevron Phillips Chemical project on the U.S. Gulf Coast; and of course, 3 trains at Gorgon and 2 trains at Wheatstone.
Turning all of these projects from cash consumers to cash producers will go a long way toward closing that cash gap; the question now is how much they will add to the mix at current prices.
Starting to realize the benefits of cost cuts
Even companies as large as Chevron and ExxonMobil are price takers in the oil and gas markets. Combined, their total oil production still is less than 5% of global production. So, the only thing the company can do in times like this is cut costs. Like with its capital spending, Chevron has been a little slower to significantly lower its operational costs, but this last quarter, the company started to show some real progress on that front, as Watson described:
[W]e're working on reducing costs across the company and are beginning to see the results. Compared to prior-year day periods, enterprise operating costs are 7% lower, in the third quarter to third quarter comparison they're 12% lower. On another basis, year-to-date upstream unit operating expenses are down 13% versus last year. At this point, we have identified spend reductions of approximately $4 billion on an annual full run rate basis. About half of this is coming through organizational reviews and portfolio rationalization and about half working through the supply chain. On the organizational side, lower investment activity, portfolio changes and efficiency reviews across the upstream, gas and midstream and the corporate and service company groups are expected to result in employee reductions of between 6,000 to 7,000. A similar number of contractor reductions are anticipated over this same period.
Shale's impact
Investors have been very enamored with shale drilling. Well, at least until oil and gas prices started to decline. There is no doubt, though, that sale has carved out a niche within the oil and gas space.
So I think that's just actually true, particularly in the United States but also around the world, so rig rates and service costs, things of that sort. So that certainly is true. It's also true that some short-cycle base business spend traditionally has lower costs once you have infrastructure in place. And it's certainly true that some of the shales are low cost.
Watson's statements are similar to other big oil players. Right now, shale is profitable on a "drill to fill" basis, which means it produces enough to fully utilize existing infrastructure. Once investments for new infrastructure need to be added to the equation, though, shale starts to look less competitive.
A shift in spending habits?
As Watson mentioned earlier, Chevron kind of got caught with its pants down with so many long-tail projects under construction. So, one thing the company plans to do in response is expand more into shorter cycle development projects like shale.
I think on balance, you'll see a higher proportion of shorter-cycle spend. 5 to 7 years ago, we didn't really have a good understanding of our Permian Basin position, for example. So you will see, over time, additional money that will go to the shale developments. And I mentioned that I had some reviews of my business units yesterday. I also had reviews with my 4 shale organizations, which are nicely sharing their successes. And the Permian is doing well. I mentioned the Marcellus is doing very well. The Duvernay in Canada, they've taken the practices and implemented them very quickly to get down the cost curve. And we're working closely with YPF and trying to put those same practices in place. We've delineated -- we know where the sweet spots are down there. Now we're starting a horizontal drilling program and we expect to get better. But I think you'll see a more balanced portfolio. And I think you'll see projects that will have good economics at moderate prices as we work to standardize and take costs down. So we'll have some optionality in the portfolio, and I just -- I can't envision having 2 big LNG projects at the same time. The Tengiz project is a significant capital project, but I don't see anything like having 2 Gorgon and Wheatstones plus several deepwater developments stacked on top of one another.
One thing shorter cycle projects can do for Chevron is give it more flexibility when it comes to setting its spending budgets. Considering how much Gorgon and Wheatstone have weighed on the company, it's hard to blame management for charting this new course.