 Increasing Chevron Fair Value Estimate on Strong Results and Accretive Acquisition

Director

Allen Good

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We expect Chevron to deliver higher returns and margin expansion thanks to an oil-leveraged portfolio as well as the next phase of growth, which is focused on developing its large, advantaged Permian Basin position.

Its latest capital plan maintains its focus on capital discipline without sacrificing growth. Thanks to improved cost efficiencies and the acquisition of Noble Energy, Chevron plans to grow production to nearly 4.0 million barrels of oil equivalent per day by 2027 from about 3.0 mmboe/d in 2023. New volumes will largely come from new production from its differentiated Permian Basin position (size, quality, and lack of royalties), where it expects to grow volumes to 1.25 mmboe/d by 2027 from about 700 mboe/d in 2022 while delivering returns of nearly 30% and about $5 billion of free cash flow by 2027. 

Chevron's Permian growth will be supplemented by expansion projects at Tengiz in Kazakhstan, due to begin producing in mid-2023, new developments in the Gulf of Mexico, and potential new discoveries in Mexico and Brazil. Chevron also now has growth options with offshore gas fields in the Eastern Mediterranean with the Noble acquisition. 

Oil and gas prices will dictate Chevron’s earnings and cash flow for the foreseeable future. However, the company is investing in low-carbon businesses to adapt to the energy transition. It recently tripled its investment to $10 billion cumulatively by 2028, with this capital flowing to emerging low-carbon areas that fit with Chevron’s existing value chains and experience. Greenhouse gas reduction projects and carbon capture and offset will enable Chevron to achieve its emission targets while investments in hydrogen and renewable fuels will give it a toehold in emerging businesses that could expand in the future. 

Chevron expects the combination of new higher-margin projects along with ongoing cost reductions and operational improvements to drive return on capital employed to above 12% by 2027. Meanwhile, strong free cash flow will go toward steady dividend growth and repurchases, demonstrating management’s ongoing commitment to capital discipline and shareholder returns.

Business Strategy & Outlook

Chevron’s returns on capital have suffered from 2015 to 2020 as a period of high investment was followed by one of low commodity prices. Although it was able to reset its cost structure in the wake of the 2015 collapse in prices, it has not been able to do enough to lift returns back to historical levels when oil prices averaged $100 a barrel. However, we continue to rate Chevron as a narrow-moat company as we think during the next 10 years it will be able to deliver excess returns, albeit well below historical levels, on a combination of an improved cost structure and addition of higher-return production volumes. Chevron is only targeting a return on capital employed of at least 12% by 2027, assuming $60/bbl, much lower than the 16% average from 2010-14 but improved from the 3.5% average from 2015-19. We forecast our return on invested capital metric used to evaluate moats to remain above the cost of capital during the next five years and rise to 12% by 2027, compared with our cost of capital assumption of 7.3%, sufficient for it to earn a narrow moat rating. 

Although Chevron is an integrated energy company, its narrow economic moat largely rests on the quality of its upstream portfolio. Chevron’s upstream segment holds a low-cost position based on an evaluation of its oil- and gas-producing assets. Its greater exposure to liquids and liquids-linked natural gas production, accounting for over 70% of total volumes, has produced peer-leading cash margins and returns of nearly 20% historically. Since 2015, however, returns have suffered in part as oil prices have fallen, but also due to overinvestment at the peak of the last cycle. 

The best examples are Chevron’s LNG projects Gorgon and Wheatstone in Western Australia. Combined the two projects added about 400 mboe/d of production capacity with high margins thanks to contractually set, liquids-based pricing. The projects were already low-return and capital-intensive given the costs associated with timing, location, and complexity, but their returns were depressed further by large cost overruns. As a result, full-cycle returns are likely to be only marginally above the cost of capital, weighing on overall segment and firm returns even as they contribute to higher per-barrel margins. 

Overall segment returns should improve, however, thanks to higher oil prices during the next five years and the addition of higher-return projects. Newer projects have superior economics and can earn higher returns at lower oil prices after rounds of cost reductions, re-engineering (standardization and simplification), and service price deflation. 

Outside the Permian, growth during the next five years should largely come from the expansion of its Tengiz project in Kazakhstan, which adds high-margin oil volumes at low break-even prices. Also, its past exploration success in the Gulf of Mexico endows it with a large set of brownfield development opportunities that are economical at less than $45/bbl. Beyond the next five years, Chevron also has opportunities for incremental capacity increases at its Australian LNG projects, which should be high return and a new, large resource basin in the Mediterranean natural gas reserves acquired with Noble for development. 

Chevron’s downstream operations consist of its refining and marketing portfolio, and its interest in the Chevron Phillips Chemical joint venture. Compared with peers, its downstream segment is relatively small with only 1.8 mmboe/d of refining capacity and few owned retail sites. We typically do not consider refining to be a business capable of earning a moat, with the exception of some U.S. refineries that hold a feedstock cost advantage. While Chevron does hold some refineries that qualify on the Gulf Coast and in the midcontinent, the bulk of its capacity does not have such an advantage, given that it is located in California. However, in past years it has improved the performance of its operations, divested lower quality assets and improved returns. Meanwhile, the CPChem joint venture is a high-quality chemical manufacturer with low-cost feedstock access in the U.S. and Middle East. While its earnings contribution is small relative to the upstream segment (30% by our forecast in 2030), it generated strong returns on capital of 18% from 2011 to 2019. We forecast at midcycle levels, returns will approach 18%, supporting Chevon’s narrow moat rating.

Chevron is exposed to several environmental, social, and governance-related risks, but these do not imperil its moat, in our view, as most fall outside the 10-year narrow-moat window or are not probable or material enough risk to cause material value destruction. Chevron’s primary ESG risk stems from carbon emissions in its operations and use of its products, emissions, effluents and waste generated in operations such as oil spills and poor community relations. 

The risk from carbon emissions is most likely to materialize through a carbon tax, which increases the price of end products to consumers, reducing demand over time and threatening Chevron’s core business. We expect carbon taxes to gain greater adoption over time, but think the impact on hydrocarbon demand remains more than a decade away. Chevron’s upstream greenhouse gas intensity is rather high for its peer group at 29 kilograms CO2e/boe (2021), making it a higher cost producer. However, it is investing efforts to improve its emissions intensity, reduce methane leakage and reduce flaring, but lacks the very long-term targets of some of its peers as well as plans to diversify away from hydrocarbons. It aims to reduce its upstream emissions intensity to 24 kg CO2e/boe by 2028 or about 35% from 2016 levels and be net zero by 2050. That just covers scope 1 and 2 emissions, however; about 90% of emissions from oil and natural gas occur during combustion (scope 3), which the company can do little about.

Chevron recently tripled its low-carbon investment to $10 billion cumulatively by 2028 to fund projects in the areas of greenhouse gas reduction, carbon capture and offset, hydrogen, and renewable fuels. The amount is less than some peers but is more focused on areas that are tangential to Chevron’s core hydrocarbon business or in the value chains it currently participates. Although these areas are still in the early stages and outcomes are uncertain, they hold greater potential for high returns and competitive advantages than more mature areas such as renewable power, where many other integrated oils are investing. Chevron expects these investments to deliver over $1 billion on operating cash flow by 2030, but given their relatively small size and uncertain future, they do not factor into our narrow moat rating. 

Oil spills are an ever-present risk for oil companies operating offshore and can be devastating to firm value, as BP’s Macondo incident in the Gulf of Mexico shows. While oil companies regularly cause spills, most are immaterial in size and associated fines and cleanup costs are manageable. Large spills such as Macondo are very rare and do not factor into any of our scenario modeling.

Narrow

Economic Moat

Chevron

Texaco, Inc. ("The Texas Company") is an American oil subsidiary of Chevron Corporation. Its flagship product is its fuel "Texaco with Techron". It also owns the Havoline motor oil brand. Texaco was an independent company until its refining operations merged into Chevron Corporation in 2001, at which time most of its station franchises were divested to the Shell Oil Company.

Texaco

Tengizchevroil is a joint venture between Chevron (50% share in the consortium), ExxonMobil (25% share), KazMunayGas (20% share) and LukArco (5% share). The joint venture was formed in April 1993, when the Kazakhstan government granted an exclusive 40-year right to Tengizchevroil LLP (TCO) to develop the Tengiz and Korolevskoye oil fields located in the north-eastern reaches of the Caspian Sea in Kazakhstan.

Tengizchevroil

Wheatstone LNG is a liquefied natural gas plant under construction in the Ashburton North Strategic Industrial Area, which is located 12 kilometres (7.5 mi) west of Onslow, Western Australia. The project is being developed and will be operated by Chevron Australia Pty. Ltd.

Wheatstone LNG

Chevron Corp. engages in the provision of administrative, financial management, and technology support for energy and chemical operations. It operates through the Upstream and Downstream segments. The Upstream segment consists of the exploration, development, and production of crude oil and natural gas, the liquefaction, transportation, and regasification associated with liquefied natural gas, the transporting of crude oil by major international oil export pipelines, the processing, transporting, storage, and marketing of natural gas, and a gas-to-liquids plant. The Downstream segment consists of the refining of crude oil into petroleum products, the marketing of crude oil and refined products, the transporting of crude oil and refined products by pipeline, marine vessel, motor equipment, and rail car, and the manufacturing and marketing of commodity petrochemicals and plastics for industrial uses and fuel & lubricant additives. The company was founded in 1906 and is headquartered in San Ramon, CA.

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Chevron said on Thursday it has the accepted recommendations from Australia's labor regulator to end its dispute with unions at its liquefied natural gas (LNG) facilities in Western Australia.

Chevron accepts Australian labour tribunal's terms to end strike at LNG plants

Chevron has accepted recommendations made by Australia's industrial tribunal, the Fair Work Commission, to end a dispute with unions at its liquefied natural gas (LNG) facilities in Western Australia, a company spokesperson said on Thursday.

Chevron accepts recommendations of Australia tribunal to end dispute with LNG unions

Australia's industrial umpire the Fair Work Commission on Thursday made recommendations on pay and conditions for Chevron and unions at its liquefied natural gas facilities to resolve their ongoing dispute.

Australia industrial umpire makes recommendations for Chevron, LNG unions to resolve dispute

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Chevron Corporation (NYSE:CVX) announced on Monday that full production had resumed at its Wheatstone liquefied natural gas (LNG) facility in Western Australia, which suffered a fault last week, even as union members continue strikes at the site.  The fault cut production at the facility by about one-fifth.

News for Chevron Stock (CVX)