Updated from 9:39 a.m. EST on Jan. 31.
Integrated oil producer Chevron
(CVX)
reported a 12.6% earnings increase over 2007, to $8.83 per share, and strong 33.7% fourth-quarter earnings growth, to $2.34 per share.
The discrepancy between the fourth quarter and the full year originates from the substantial increase in the price of crude over the year. Volumes declined , however, and downstream margins were anemic.
Fourth-quarter and full-year revenues increased by 28.6% and 5%, respectively, to $220.9 billion and $61.4 billion.
While the company is investing heavily in upstream gas and exploration worldwide, possibly securing volumes long term, for the time being, company earnings depend on favorable pricing winds, partly dependent on OPEC quota decisions. It should be noted that the return on capital employed for the company didn't budge, at 23.1%, while operating margins remained stable at 28.7%.
(Note: All of the following results will be for the full year, unless indicated otherwise.)
Upstream income for the year increased by 12.7%, to $14.8 billion, and constituted 79% of income. Total upstream net oil equivalent production declined slightly by 1.8%, to 2.62 million barrels per day. Natural gas volumes increased slightly by 1.3%, to 5 billion cubic feet per day, while liquids production stabilized at 1.8 million barrels per day.
The outlook for production volume for 2008 depends crucially on the anticipated price of oil. At a price of $70 per barrel, production is expected to increase slightly to 2.65 million barrels of net oil equivalent production.
Increasing upstream production is one of the major goals of Chevron. To that end, it is devoting the lion's share of its 2008 $22.9 billion capex to upstream production. The company will devote 76% of its 2008 capex budget to exploration activities in diverse areas such as Angola, China, Kazakhstan and Thailand.
Management maintains that production volumes between 2005 and 2010 will increase by 3% annually. On the other hand, over 2007, weak production volumes were explained by adverse effects such as weather-related production decreases, well write-offs and a drop in Canadian volumes, emphasizing how sensitive company profits are to capricious and uncontrollable events.
Turning to the story in downstream, income declined yearly in this segment by 12% due to lower refining margins over the fourth quarter. The 25% increase in international downstream income (13% of income) over the year was offset by the 5% decline in U.S. downstream income (5% of income) over the same period. Revenue declined by 3.8% in this segment over the year, while refinery input declined by 7.8%.
The difference between fourth-quarter and full-year trends was especially marked in this segment. For instance, over the fourth quarter, downstream income declined by 79%, most of that driven by a 116% decline in U.S. downstream income. A $30 million decline in U.S. downstream volumes was offset by a $280 million volume increase internationally in the ultimate quarter of 2007.
Additionally, Chevron's reserve replacement ratio declined to the 10% to 15% range due to sales and acquisitions and the rising price of oil over the year. An upgrade to the company's South Korean refinery operations should increase earnings somewhat in this segment over 2008.
Chevron's chemicals division (2% of income) continued to weather a decline, as profits decreased over the year by 26.5% due mostly to lower margins on olefins.
Despite the fact that cash declined by 35%, Chevron's debt-to-capitalization ratio declined by 390 basis points, to 8.6%.
Overall, the outlook for 2008 depends crucially on Chevron's ability to stabilize upstream production.
CVX Preview: The Price/Production Dilemma
Oil operator Chevron
(CVX)
would seem to be sailing smoothly ahead, with the company's full-year 2007 earnings are anticipated to grow by 5%, to $8.36 per share. Chevron, however, is being ratcheted between the beneficial effects of significant price increases for intermediate and high-quality crude, on the one hand, and declining -- if not stagnant -- production volumes on the other.
For the fourth quarter of 2007, earnings are expected to increase by 29%, to $2.24 per share, with price effects anticipated to trump production effects. Earnings are thus expected to reflect the steep price increase in crude seen toward the latter half of the year, as illustrated in the following chart.
Fourth-quarter and full-year revenues are expected to follow the same trend, the former increasing by 60%, to $76.09 billion, and the latter by 7%, to $224.64 billion.
Chevron's 52-week stock price return was 22%, with a dividend yield of 2.1%.
As the fourth-largest integrated oil producer in the world, Chevron faces a slightly different game than larger competitors Exxon Mobil
(XOM)
or BP
(BP)
. Unlike Exxon, which has been ousted from Venezuela, Chevron has retained a minority interests in its oil stakes in that area. Nevertheless, the company must face considerable uncertainties in newly developing projects in Kazakhstan, and possibly Greenland. (This country, due to global warming and receding glaciers, is considering leasing new tracts to the major oil companies, much to the dismay of lovers of those wild northern zones.)
Additionally, Chevron is looking at developing biofuels from algae and oil sands in Canada in an effort to expand its production base. Over the first nine months of 2007, the company's upstream production growth was almost nil, stabilizing at 2.6 million oil-equivalent barrels per day. Consequently, the increase in the price of crude was offset by the lower volumes, keeping upstream income more or less constant at $9.9 billion.
This would not be problematic, per se, since upstream income for Chevron constitutes 16% of revenue, downstream income constitutes 83%, and the company's declining chemicals segment contributes the rest. But securing upstream production is one of Chevron's preoccupations, since capital expenditure growth in this segment, at 21%, far outpaced downstream capital expenditure growth of 3%.
The paradox is that relatively higher refining margins internationally contributed to the 60% upstream income growth and to most of the EPS growth of 6.6% that the company experienced over the first nine months of 2007. High international margins were offset by refinery downtime problems in the U.S. as well as a decline in the sale of gas oil and jet fuel.
Looking ahead to 2008, it should be noted that U.S. gasoline inventories in January rose by 3.6 million barrels, or by 1.2% over the same period last year, while demand was 1.4% higher than last year, according to the Energy Department. The net effect might be to reduce U.S. oil companies' 2008 downstream income.
Current balance sheet considerations might also adversely impact future earnings. Chevron reported an inventory increase (of crude and refined products) of 23% over the first nine months of 2007, with the possibility of depressing prices in the future. The company seems to keep its debt-to-capitalization ratio reasonable at 7%, but cash declined by 24%.
Even if Chevron manages to maintain decent earnings growth over 2007, considerable problems are likely to loom for the company in 2008.
At the time of publication, Vijayraghavan had no positions in the stocks mentioned.Vasu Vijayraghavan was an academic finance professor at the University of Paris who has now turned to a new career as a financial consultant. As an academic, she wrote on corporate governance issues, especially in the European context, and she believes in a long-run and balance sheet approach to stock picking.
Currently, Vasu is working as a consultant for lawyers, doing business valuation. She is a Level II CFA candidate and enjoys writing long/short and earnings calls pieces for TheStreet.Com.
Vasu holds a Ph.D. from the University of Michigan and a B.A. from Harvard University.
