World Will Need Big Oil
There are those who will tell you that this is a bad time to be running a big oil company. John Watson, chief executive of Chevron, is not among them. “Arguably, we’ve never been more advantaged than right now,” he says.
Of course, he acknowledges, times are tough for everyone in the oil industry because of the plunge in prices for crude and natural gas since the summer of 2014.
Compared to his competitors, though — whether the smaller independent oil producers in the US or the big national oil companies in emerging economies — Chevron is better placed to ride out the downturn and benefit from the upturn when it comes, he believes.
Critics of Chevron and the other big international oil companies suggest their business model is under threat, trapped in a pincer movement between the leaner and more agile shale operators, and curbs on demand for oil and gas imposed by government policies to reduce the threat of climate change.
In an interview with the Financial Times, Mr Watson, a 36-year Chevron veteran, rejects that critique. “I expect [Chevron] to be a viable and vibrant business for a long time,” he says. “There is still a good connection between economic growth, prosperity and consumption of energy. And we’re going to need all forms of energy.”
With oil at $52 per barrel, which was the average price of Brent crude last year, Chevron does not look like a business with a great long-term future.
Its return on capital employed last year was just 2.5 per cent, and its cash outflows including capital spending and dividends exceeded its cash from operations by $22.5bn. Over the past five years, the company’s shares have significantly underperformed the S&P 500, reflecting a squeeze on profitability that began even before the slump in oil prices.
Mr Watson, however, argues that the factors that determine Chevron’s financial position will “come together pretty nicely for us over the next year or so”.
Between 2009 and 2012, Chevron embarked on an extraordinary investment binge, committing to a wave of very large projects. At its peak in 2014, its capital and exploration spending exceeded that of its rival ExxonMobil, even though Exxon’s market capitalisation was more than 80 per cent greater.
Chevron CEO John Watson
Now Chevron’s large projects are reaching completion. Gorgon, the $54bn liquefied natural gas development in Australia that is the largest of them all, is expected to ship its first cargo next week.
Others, including Wheatstone, another big LNG plant in Australia, and Big Foot, a deep water oil development in the Gulf of Mexico that was delayed by equipment failure, are coming on stream over the next couple of years.
As a result, Chevron’s oil and gas production is expected to grow by 13 per cent between 2015 and 2017, and continue increasing by about 1 per cent per year after that. Exxon’s production, by contrast, is expected to be roughly flat out to the end of the decade.
“As we finish those projects that are under construction, our capital spending will come down, and we get the added benefit that as those projects are coming on line, we will generate more cash,” says Mr Watson.
Due to cost-cutting, with 7,000 jobs going during 2015 and 2016, and the completion of those large projects, Chevron expects to be able to cover its capital spending and its dividend payments from its cash flows next year if oil is again at $52.
If oil is lower than that — Brent crude is this week trading at about $40 per barrel — then Mr Watson is prepared to keep borrowing to pay the dividend, because its shareholder base values the “predictability” of the payout.
Part of the price of that is Chevron has put the brakes on new projects. The company did not give the go-ahead to any large developments in 2015, and this year expects to approve just one: an investment to increase production at the huge Tengiz oilfield in Kazakhstan.
Instead, Chevron will focus on much smaller investments, such as additional wells to boost production at existing projects, and development of its own shale oil reserves in the Midland and Delaware basins of west Texas.
Chevron has an excellent position there: it calculates that it could drill 1,300 wells that would be financially attractive even with oil prices below $40, and it plans for production in west Texas to double by 2020, and possibly rise even faster.
Big projects, however, are the raison d’être of large oil companies, which are the only businesses with the financial strength and technical expertise to develop them.
In shale, the big international oil companies were slow to see the opportunity, and have lagged behind their smaller rivals in efficiency. Chevron says it is catching up, but if the future of the oil industry lies in shale, then the big companies seem to have no decisive competitive edge.However, Mr Watson argues that the hold-up in large projects is just a temporary hiatus. In the short run, the global oil market is oversupplied, and may remain so for a while, because of factors including the resilience of US shale and production from Iran coming on to world markets after the lifting of sanctions.
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By the 2020s, he argues that big capital projects will be needed again. Shale can provide additional supply to meet rising demand for oil for a few years, but not forever.
“Shale is roughly 5 per cent of world supply,” he says. “As you think forward . . . Shale will be insufficient to meet that demand. We will need other classes of assets.”
While times may be hard for Chevron as it waits for that upturn, he adds, others have it even worse.
“We don’t have the stresses and strains that the independents have with stressed balance sheets,” says Mr Watson. “We don’t have the stresses that national oil companies have, where they’re trying to choose between reinvesting in the business at low prices [and] trying to feed their people and meet the social obligations that they have.
“At any kind of moderate prices, we’ll be growing production through the end of the decade, with good investments going forward. Others may not have that opportunity.”
Financial Times
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