(NYSE: CVX) Chevron’s 2 most important projects are now its biggest headaches
Heading into 2016, Chevron (NYSE: CVX) investors held their hopes high due to the company’s two major upstream projects set to come on-line over the next year. These are its Australian liquefied natural gas, or LNG, projects -- Gorgon and Wheatstone. These massive projects could be home-runs for Chevron over the long-term. LNG is easier to transport and ship than traditional natural gas, because in its liquid form it can be suppressed to smaller volumes. For Chevron, the two projects are positioned perfectly to capitalize on growing demand in emerging markets in the Asia-Pacific region such as China.
But while the long-term picture looks extremely bright, the short-term is muddled with uncertainties. Chevron recently suffered major delays at both projects which threaten to postpone production even further and raise costs even more.
Why natural gas?
Natural gas stands to be one of the fastest-growing sources of energy over the next several decades, because it offers a number of relative benefits versus other fossil fuels such as coal. For example, natural gas generally has a much lower carbon footprint than other fossil fuels—including far lower emissions of nitrogen oxide. Nitrogen oxide is a family of poisonous gases that are formed when fuel is burned at high temperatures. When used as a vehicle fuel, natural gas has 80 percent fewer nitrogen oxide emissions and 75 percent fewer particulate emissions than diesel. Furthermore, when compared to propane, natural gas has 15 percent fewer greenhouse gas emissions. LNG is particularly attractive from an environmental perspective, because LNG spills do not require any remediation of soil, groundwater or surface waters because it evaporates immediately into the atmosphere.
As a result, not only will the incorporation of LNG into Chevron’s production portfolio improve the company’s financial position, but it also stands to improve the carbon intensity of Chevron’s business. The company could use a boost in terms of its environmental effects—according to the Carbon Disclosure Project, which seeks to generate more disclosure from companies regarding their environmental impacts. In 2016, Chevron did not submit reports pertaining to its climate change or water usage. It received a grade of ‘B’ in 2015 on the metric of climate change, but this was down from a grade of ‘A-‘ in each of the past two years.
Implications for investors
In April, Chevron announced the Gorgon project would be taken off-line for up to three months, due to technical difficulties at the facility. According to the company, there are problems with the propane refrigerant circuit, an essential component for cooling natural gas into its liquefied form. This was a severe blow to the company because it finally started first production at Gorgon in late March.
If that weren’t bad enough, in February Chevron announced that its other major Australian LNG project, Wheatstone, would be delayed another six months. The company does not expect Wheatstone to produce until mid-2017. Chevron’s CEO attributed this delay to slower-than-expected construction.
These are significant setbacks for Chevron. The Gorgon and Wheatstone projects are critical to fueling the company’s future growth. Both projects took several years to complete and were beset by repeated delays and massive cost-overruns. The Gorgon project itself cost $54 billion, which came in $17 billion above budget. Analysts also suspect the Wheatstone project will come in significantly above the $29 billion official cost figure provided by Chevron.
This matters greatly to investors because Chevron stock has rallied off its 2016 low of $69 per share to its current level of $101, based in large part on management’s vow to investors to become cash-flow neutral by 2017. In other words, the company has stated it can generate at least as much operating cash flow, as it spends on its capital expenditures each year. To get there, Chevron needs to finish completion of its major upstream projects and thus turn these projects from uses of cash to sources of cash. Collectively, the two projects could produce in excess of 24 million tonnes of gas each year for decades. With the Gorgon and Wheatstone projects both being delayed, its 2017 cash flow objective is now in doubt.
Analysts are becoming increasingly negative
This could not come at a worse time for Chevron. The company’s financial position has eroded over the past two years due to the steep declines in commodity prices, and now, just as oil and gas prices are beginning to recover, two of its most important production facilities won’t be able to participate. In addition, Chevron has received poor ratings from the analyst community in recent weeks, and this situation certainly won’t help in that regard. On Apr. 8, credit rating service Moody’s downgraded Chevron’s credit rating to Aa2. If that isn’t bad enough, another major credit rating service, Standard & Poor’s, also downgraded Chevron from AA to AA-.
The most recent analyst change came from Raymond James, which downgraded Chevron from outperform to market perform. Indeed, analysts do not see much upside for Chevron stock. The mean price target for Chevron is $103 per share, just 2 percent from Chevron’s current price. This implies analysts widely believed there are not much further gains in store for Chevron stock.
The rationale is that with commodity prices finally recovering off their lows, after a painful two-year downturn, Chevron could miss out if its projects don’t get back on-line soon.
Companies to watch
Royal Dutch Shell (NYSE: RDS-B): Chevron’s gains could be other LNG players’ collective gain. The longer it takes Chevron to get these projects on-line, the more market share will be claimed by other companies like Shell, which are investing heavily in LNG. Shell has its own ambitions in natural gas, as it acquired major gas producer BG Group in a $70 billion transaction this year. The transaction officially closed in February, and instantly made Shell the biggest LNG producer in the world.
However, it’s not all good news for Royal Dutch Shell, as it and Exxon Mobil (NYSE: XOM) each own 25 percent stakes in the Gorgon project. Of course, investors will remember that Exxon Mobil itself is a huge natural gas producer, fueled by its $41 billion deal for XTO Energy in 2009.
Other European oil majors, Total (NYSE: TOT) and Eni (NYSE: E) are also investing aggressively in LNG to cater to the Asian markets. Total’s premier LNG project, Yamal, is located in Russia. Yamal has a total annual production capacity of 16.5 million metric tons, and is slated to begin production in 2017. Eni has focused its LNG ambitions on Africa. It has a massive LNG project in Nigeria, Angola, and Mozambique. Its Mozambique LNG field is particularly compelling. One individual location in the Mozambique field, Area 4, has approximately 85 trillion cubic feet of gas potential. This will require a longer period of development—first startup is not expected until 2020.
Bob Ciura is an independent equity analyst. Since 2012, his work has focused on fundamental investment analysis of publicly-traded companies in the energy, technology, and consumer goods industries. Bob has a Bachelor's degree in Finance and an MBA in Finance.