- Chevron stock has gained this year on the back of improving market sentiment, but things can turn sour rather quickly.
- Oil will, however, rise in the long term on improving demand and supply fundamentals.
- If it does, then Chevron could be the biggest beneficiary as compared to other oil super-majors like Exxon Mobil and Royal Dutch Shell.
Chevron (NYSE:CVX), one of the world’s leading vertically integrated oil producers, has gained roughly 5.3% this year on the back of a recovery in oil prices. But short-term oriented investors should approach this stock with caution.
Oil prices have gained substantially, with the benchmark US and European crudes currently hovering near $40 a barrel after touching multi-year lows of less than $27 a barrel last month. This incredible gain of roughly 50% has been powered by a number of factors, including declining US production following its peak of 9.7 million barrels a day in April last year, strong gasoline demand in the US and supply issues in Iraq and Nigeria, but the biggest of them all is the speculation that major OPEC and non-OPEC producers, led by Saudi Arabia and Russia respectively, will reach some sort of an agreement to freeze output. Ten of the biggest oil producing nations, with the exception of Libya, have planned to meet in Qatar on April 17 to discuss the supply situation.
If they fail to reach any agreement, then I believe the market sentiment could turn sour very quickly, which could potentially wipe out all the year-to-date gains made by Chevron. But if the big producers agree to freeze output, then there are still doubts over whether such a deal can actually be implemented. Remember, the last time major producers, including Russia, signed a similar deal in 2001, Moscow kept growing its oil exports. On top of this, there are major headwinds that could keep a lid on further oil price appreciation.
Firstly, the production ramp ups from Iran haven’t been as bad as the markets feared. The country’s output climbed by 250,000 to 310,000 barrels a day, according to International Energy Agency and OPEC’s estimates for the first two months of this year. That’s smaller than half a million barrels a day targeted by Iran. But the country’s is still seeking to increase output by 1 million barrels a day by as early as June. That should keep oil prices under pressure.
Secondly, with all the focus on next month’s meeting, the oil market seems to have forgotten about a serious supply overhang, with near-record quantities of crude stored all over the world. In Cushing, Oklahoma, the primary US storage hub, crude oil stockpiles are currently sitting at 532.5 million barrels - the highest level in more than eight decades.
Thirdly, the poor health of the global economy -- with China’s slowdown, little growth in Europe and recession in some Latin American countries such as Brazil -- could also weigh on oil’s demand.
Despite these headwinds, the long-term outlook for oil is still looking positive. Although demand growth has slowed, it hasn’t stalled. OPEC’s most recent Oil Market Report saw demand climbing by 1.25 million barrels a day in 2016. The demand for gasoline, in particular, is still growing at strong rates outside of the US and Canada, as highlighted recently by Credit Suisse.
Meanwhile, the prolonged weakness will eventually lead to supply cuts since most of the world’s oil does not breakeven at $40. In the US, which is responsible for most of the world’s shale supply, a majority of the producers need oil to be at $60/ barrel, at least, to survive. Most of the OPEC and non-OPEC members, including the cash-rich Saudi Arabia, also need higher oil prices to maintain economic growth.
Slowly but surely, the oil price environment will reach a new normal. We can’t be sure what this might be, but we can say with a fair amount of certainty that oil at $40 can’t last for long. The strength in oil prices could change the fortune of every oil super-major, namely Chevron, Exxon Mobil (NYSE:XOM), Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) and BP (NYSE:BP) who’ve struggled with declining shares, near-record losses and shrinking cash flows. But Chevron could be the biggest beneficiary of strength in oil prices.
That’s because the company has greater exposure to oil than its peers. Exxon Mobil, for instance, produces greater quantities of crude than any other publicly listed oil producer. In the fourth quarter, Exxon Mobil’s liquid production clocked in at 2.48 million barrels a day. But 41.6% of Exxon Mobil’s total output was natural gas. In fact, Exxon Mobil is the leading US natural gas producer, ahead of Chesapeake Energy (NYSE:CHK).
Similarly, Royal Dutch Shell, which recently became the world’s second largest oil producer in terms of market cap following its acquisition of BG Group, also has significant exposure to natural gas which accounted for nearly half of the Anglo-Dutch company’s fourth quarter output. Chevron, on the other hand, produced 1.78 million barrels of liquids in the fourth quarter, and that was 66.4% of its total output.
On top of this, Chevron’s liquid exposure could expand in the coming years. The company has recently ramped up oil rich projects, such as Jack/St. Malo, Tubular Bells in deepwater Gulf of Mexico as well as started new oil-focused projects such as Lianzi and Moho Bilondo in offshore Africa. Continued ramp up of major oil rich projects and startup of new ones, such as Mafumeira Sul located in offshore Angola which is projected to come online in the second half of this year, will keep Chevron heavily exposed to oil prices.
But more importantly, Chevron has recently shipped its first LNG cargo from the massive $54 billion Gorgon LNG project in offshore Australia. Chevron, which is the majority owner and operator of the project, has said that Gorgon will be running at full capacity by the second half of next year. By then, the neighboring Wheatstone LNG project would also have come online. As a result, Chevron is positioned to significantly grow its LNG profile, and by that extension, its exposure to oil, since LNG contracts are benchmarked to oil prices.
Chevron’s near-term outlook continues to look uncertain, but oil’s supply and demand fundamentals will improve over the long term, which will have a positive impact on prices. Chevron could be the biggest beneficiary of an uptick in oil prices. The company’s stock will likely outperform other super-majors on oil’s recovery, given Chevron has greater leverage to liquids than its peers. The recent project expansion work and startups can make its future even more closely aligned with oil prices.