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Big Picture

Big Oil is Back

By Roger S. Conrad, on Oct. 1, 2018

I became a shareholder of Chevron Corp (NYSE: CVX) when it acquired the former Texaco, which I believe was the first stock I ever bought. I was fresh out of business school and made an investment in Texaco’s dividend reinvestment plan, and I’m happy to report that I literally make more in dividends every year than my original investment. I expect to pass the whole thing on to my kids, hopefully many years from now with the account at a much higher level.

That return is thanks to super majors being literally built for anything. Chevron has obviously done better with oil over $150 but it’s also held up at $10 a barrel. In fact, I just went back through 40 years of dividend history and this company has never once cut its payout. And looking back at my initial DRIP statements, my per share quarterly dividend is nearly 10 times more than it was when I bought in.

There have obviously been other energy stocks that have outperformed Chevron over the years. And the same goes for the other super majors. But nothing in the energy space has come close to the steadiness of these stocks.

The big question I always ask about the super majors like Chevron is whether something has changed in the sector environment to threaten that staying power. And the past several years have posed a pretty severe challenge to management teams. That started with the aggressive investment plans we saw Chevron and others embark on early in this decade to develop long-life oil and gas projects.

Initially the super majors’ plans included everything from the pre-salt off the coast of Brazil to Alberta oil sands and giant Australian liquefied natural gas export projects like Gorgon and Wheatstone. For the most part, the development has been well executed. But companies still had to cope with the impact on capital markets from falling oil and gas prices, and quite a bit of second-guessing from the analyst community on the prudence of investing in long-life projects. Now that many of these projects have come on stream and energy prices have rebounded, you don’t hear a lot of that anymore.

The other thing that impresses me about how Chevron handled the downturn is that it successfully shifted tactics, without sacrificing the goals of its strategy. What I mean by that is management didn’t reach its goals by following through on every project it announced in 2012. Rather, it recognized what was working and shifted resources there.

One of its biggest success stories is in the Permian Basin of west Texas, a region management hardly mentioned at the beginning of the decade. Now it’s a primary source of the company’s production growth along with the Gorgon and Wheatstone LNG projects. Being able to shift to fresh horses in the middle of a heavy development phase is a strength that’s pretty much unique to the super majors.

Another point that helps the majors is that they’re usually diversified beyond exploration and production (E&P) for oil and gas into other businesses like refining, chemicals and midstream (pipelines and terminals). These businesses can act as an automatic stabilizer for the majors in periods of low commodity prices.

Let’s take Chevron for example. The company divides its business into several segments including Upstream (E&P), Downstream (Refining) and Chemicals. In 2013, when oil prices were still up over $100/bbl, the upstream business accounted for nearly 80% of Chevron’s net income with downstream and chemicals each chipping in around 10%.

However, when oil prices collapsed in 2016, upstream generated barely 2% of the company’s total net income while downstream was around 47% and refining over 50%. Refining and chemicals businesses became more profitable as oil, natural gas and natural gas liquids prices fell and helped offset a massive collapse in upstream earnings.

I’m not saying that refining and chemicals can offset all the declines in profits due to falling oil and gas prices, but it’s a meaningful “ballast” for a company like Chevron.
If I had to pick just one super major right now it would be Chevron. True, the company is exposed to Indonesia, where the government is apparently considering nationalizing foreign investors’ energy assets in advance of April 2019 elections. Whatever it might lose there, however, the company figures to make up manifold in places like the Gulf of Mexico, the Permian Basin and Australia, where the Wheatstone LNG facility became fully operational this year.

Chevron has won a potentially valuable contract with Iraq’s Basra Oil to develop fields in the southern part of the country, a long-time Holy Grail for super majors. And it’s already a big player in Argentina’s Patagonian shale, which has been called by some “the next Permian Basin.” Those are part of some $79.5 billion of active development projects cited by Industrial Info Resources.

Meanwhile, the company is on track to generate $17.5 billion in free cash flow for 2018 after $13.5 billion in CAPEX. That’s enough to cover cash dividends paid by more than a 2-to-1 margin, leaving nearly $9 billion for debt reduction, stock buybacks, acquisitions and other uses. It’s a great position to be in and the stock is also not expensive at 13.7 times expected 2018 earnings. Chevron is a strong buy even for conservative investors up to $125.

Finally, for more on global energy markets and 5 profit steps we’re recommending right now, check out this presentation, available with my compliments, by tapping here:   https://www.energyandincomeadvisor.com/oil-renaissance

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