(NYSE: CVX ) Why natural gas is Chevron’s fuel of the future
In the search for new sources of energy and diversified portfolios, Big Oil is quickly embracing natural gas. In particular, liquefied natural gas, or LNG, is getting a lot of attention. The global integrated oil majors are plowing billions of investment dollars into discovering and producing LNG. There is perhaps no company that has made LNG a bigger strategic priority than Chevron (NYSE: CVX).
LNG as part of a lower-carbon energy mix
Chevron’s two huge LNG facilities are called Gorgon and Wheatstone. Wheatstone is a $29 billion project which includes two LNG trains with a combined capacity of 8.9 million tonnes per annum and a domestic gas plant. First shipments are expected in late 2016, although the project has encountered recent delays that could shift completion to next year.
Meanwhile, the Gorgon development is one of the world's largest projects, and analysts are busily covering it due to its massive importance for Chevron. Business Finance News analyst Camilla Pritchard notes that the Gorgon project is “Australia’s largest ever single resource project”. Chevron stated in its most recent earnings call that Gorgon is approximately 90 percent complete and should ship first gas this year.
From a strategic and environmental point of view, there are many benefits to Chevron’s pursuit of LNG production. LNG is much colder than other liquids, a byproduct of natural gas being cooled down to extremely low levels. This is done because in its liquid form, the gas is much easier to store and transport. The liquefied form does not need to be stored with additional pressure, which means it occupies much less space than traditional natural gas. Industry peer Exxon Mobil (NYSE: XOM) has stated that liquefying natural gas reduces its volume by 600 times. This allows for safer and more cost-effective transportation.
Ease of transportation is critical from a logistics perspective. The reduced volume of LNG makes it economically possible to send large amounts of it over long distances. Once the LNG reaches its end destination, it is then warmed up again to reclaim its gas form, in a process known as “regassification”. It can then be transported via pipeline, like traditional energy liquids, to eventually reach its end users. This is why Chevron has planted its flag in Australia, where supplies are abundant. And, the relative ease of transportation makes it economical to serve the rapidly-growing markets in Asia, including China, where demand for energy remains high.
Additionally, Big Oil is holding out hope that LNG can be part of a lower-carbon energy mix. Oil companies claim that natural gas is half as polluting as coal for power generation. Furthermore, LNG has a number of benefits versus diesel fuel, including 20 percent-30 percent fewer carbon dioxide emissions than distillate fuels, and LNG emits 75 percent less nitrogen oxide, a leading contributor to smog and ozone pollution, than diesel.
Contributions to Chevron’s bottom line
As a result, it makes complete sense for Chevron to aggressively pursue LNG production. From a financial perspective, the Gorgon and Wheatstone projects have the potential to significantly boost Chevron’s future earnings. With commodity prices so low, Chevron’s bottom line is under pressure. Chevron’s earnings fell 63 percent last quarter, year over year, from $5.5 billion to $2 billion.
The benefits of ramping up of the Gorgon and Wheatstone projects are two-fold. First, production will immediately add to revenue. Chevron expects 13 percent to 15 percent growth in production over the next two years, due largely to its LNG efforts. Second, margins and free cash flow will improve, as the projects become sources of cash rather than uses of cash. This will be critical to Chevron preserving its dividend, which is of paramount importance to shareholders. Over the first nine months of 2015, Chevron generated $28 billion of cash, but utilized just as much in cash outflow, due mostly to $22 billion in capital expenditures. Chevron’s ability to continue paying its dividend at $35 oil depends largely on improving its free cash flow metrics.
Once the Gorgon and Wheatstone come on-line, Chevron’s capital expenditures will be cut dramatically. This is why the company expects to have its dividend fully covered by free cash flow by 2017. As a result, from both an environmental and financial standpoint, it is clear why LNG is the fuel of Chevron’s future.
Companies to watch
Exxon Mobil has its own LNG ambitions. It has built a massive LNG facility in Papua New Guinea that, once completed, will produce 6.9 million tonnes of LNG per year. It is expected that over the anticipated 30-year lifespan of the project, over 9 trillion cubic feet of gas will be produced and sold.
Royal Dutch Shell (NYSE: RDS.B) In a joint venture, Royal Dutch Shell operates the $28 billion LNG Canada export terminal. LNG exports are a critical strategic imperative for Canada, seeking to find new revenue in a time of depressed oil and gas prices. This project would ship LNG to Asia, and it recently was granted a 40-year export license by the Canadian government.
Total SA (NYSE: TOT) is another major player in LNG. Its two major LNG projects are Yamal (Russia) and Ichthys (Australia). Both projects are expected to start-up next year. These are significant projects that will meaningfully boost Total’s production levels. Yamal and Ichthys have annual production capacity of 16.5 million metric tons and 8.94 million metric tons, respectively.
BP plc (NYSE: BP) In October, BP signed a 20-year LNG supply agreement with China Huadian Corp., an operator of power stations in China. Under the terms of the deal, BP will supply China with 1 million tons of LNG per year over two decades. The deal could be worth as much as $10 billion.
Disclosure: The author is long BP
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.