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3 Things Chevron Management Really Wants You to Know

By Jay Yao - May 10, 2016 at 4:06PM

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Although first-quarter earnings were disappointing, Chevron management largely reassured investors on the company's near-term outlook. Here are three key takeaways from the conference call.

Jack-up platform. Image source: L.C. Nøttaasen via Flickr.

Chevron (CVX 1.64%) recently reported its first-quarter earnings. Although the company missed analyst estimates by $0.19 per share with a negative EPS of $0.39, Chevron management largely reassured investors in their commentary on the company's near-term prospects, and the company's stock didn't by fall very much. Here are three things Chevron management really wants you to know from the conference call.

1. Chevron's operating expenses continue to decline
Chevron is doing its best to contain costs in the low crude price environment. The company has pruned the number of third-party service providers and is doing more engineering itself. Management has trimmed the employee headcount by 4,000 from 2014 levels and is on track to cut the headcount by 8,000 overall. The company has improved drilling efficiencies everywhere from the Permian to Thailand. Because of the cost-containment efforts, Chevron's rolling first-quarter 2016 operating expense was 6% lower than that of the same period last year. Because of its strong balance sheet, Chevron has the opportunity to lock in low service company fees for a long duration even if crude prices rebound.

2. Production will increase
After running into some mechanical troubles that interrupted supply, Chevron management plans to bring back online Train 1 of Gorgon in early May. Chevron owns 47.3% of the Gorgon LNG project, and the ramp-up of the three trains in the Gorgon and two LNG trains in Australia's Wheatstone over the coming two years will help Chevron achieve its goal of increasing production to 2.9 million to 3 million BOE per day, from the current 2.62 million. Management gives more color on the financial impact of the production increases:

Production increases will occur as we bring on and ramp up projects. While volume growth is sensitive to any number of unknowns, such as prices, divestment, ramp-up profiles, we anticipate volume growth through the end of the decade using reasonable estimates for these and other uncertainties. The cash generation of the new assets coming online is substantial, to the point where these production adds are expected to raise the overall cash margin per barrel of the entire portfolio, even absent any increase in price.

3. Chevron is committed to the dividend
Management has repeatedly said that the dividend is Chevron's first priority. It stressed the point again on the first-quarter conference call:

Preserving and growing the dividend is our first priority. Our intention is to be able to cover the dividend in 2017. Our capital spend profile is coming down. We are completing major capital projects already under construction but otherwise reducing long-cycle spend. We are lowering our cost structure to better match a low price environment by improving efficiencies, streamlining the organization, and working with suppliers to achieve cost reductions.

Although crude prices are below $50 per barrel and global LNG prices are weak, Chevron has the financial strength to pay its dividend and withstand low prices until the ride turns for the industry. Chevron has an "AA-" credit rating and is modestly levered with a debt ratio of 22%. If things get worse, Chevron can always do a scrip dividend program to save on cash, as other super-majors have offered.

Crude fundamentals have improved
Crude fundamentals have improved. Oil service company Schlumberger (SLB 0.23%) thinks the current oversupply might be gone by the end of the year, with crude demand expected to rise by 1.4 million barrels per day in 2016 and non-OPEC production continuing to decline. Non-OPEC production fell 930,000 barrels in the first quarter, and U.S. crude production is continuing to decline by 50,000 to 100,000 barrels per day per month.

Some investors fear that rallying crude prices could lead to a large increase in U.S. shale production in a short span of time that would kill off the crude recovery. Although the concerns have some merit, given the inventory of 500,000 barrels per day of shale production of unfracked wells the worries beyond that half a million barrels a day are overblown, because there will probably be a lag between the crude price rise and an increase in E&P investment resulting from the need for many North American shale drillers to repair their highly levered balance sheets.

Given that many investors have been bitten once by being overly bullish in the middle of 2015, growth financing appetite in the capital markets will not be as great, and many shale E&Ps will need to live with their cash flow to finance their growth plans. Given that many North American shale independents have maxed their debt capacity and averaged negative free cash flow at higher prices, the prospect of rapidly rising North American production beyond those 500,000 barrels per day of inventory is not likely.

Although North American drillers have cut costs, not all of the cost cutting is due to technology improvements or efficiency gains. A substantial percentage of the cost cutting is due to lower service company contract costs, which will increase as crude prices rise, and the high grading of production to the sweet spots of a shale play where the  economics are the best.  

There is also the prospect of supply disruption as the recent forest fires in Canada illustrate. Although the fires are no longer in danger of moving closer to Canada's oil sands because of favorable weather, the disruption has removed around 1 million barrels per day of production from the market. Because many of the oil sand companies' employee's homes have been damaged or destroyed, it will take some time for the oil sand producers to find adequate logging and ramp up production again.

The improving fundamentals ensure that Chevron's debt doesn't go too high and allows Chevron to pivot to more flexible, shorter-cycle projects with better economics. Those factors, in conjunction with Chevron's lower operating expenses and higher future production, lower Chevron's downside and improves the sustainability of the dividend.

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