Grow production or preserve capital? This is the question that haunts every oil and gas producer's management team. For years, they have always had to choose one or the other. Chevron's (NYSE: CVX) management thinks it can accomplish both of these things at the same time, though, and it's banking on one asset it thinks can make it happen: The Permian Basin.
Here are a few quotes from Chevron's management team from its most recent conference call that highlight why it thinks the Permian can be such a formidable force for its portfolio in the coming years.
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Pulling in profits from the Permian
It's been rather easy to be critical of Big Oil companies and their performance in North America's shale patches for the past several years. North American production profitability has consistently been a stain on earnings reports, and Wall Street analysts have been quick to point out that smaller, more nimble independent producers were outpacing their larger cousins.
One element that many didn't take into account was the fact that Chevron and others were trying to get their graduate degrees in shale drilling before heading to work. Much of their prior work was dedicated to exploration wells to evaluate a resource or test wells to determine how to extract the resource better.
Those efforts are starting to pay off. According to upstream Vice President James Johnson, Chevron has made a lot of progress on turning its Permian Basin shale production into a highly profitable venture.
Later in the call, Johnson explained that with oil prices at $50 a barrel, a large portion of its holdings should generate better-than-30% returns fully burdened. Fully burdened return means it includes the ancillary costs such as facilities and land, not just the costs to drill the well.
Turning the production dial up to 11
Now that Chevron has determined how to turn its shale holdings into assets that can generate free cash flow and not just grow production, Johnson foresees the company ratcheting up production quickly:
An annual growth rate of 35% over several years will completely transform Chevron's production profile. As it stands today, the company expects to produce 450,000 barrels per day from its Permian shale by 2020. At its current development rate, though, it could blow past those projections.
At this rate, Chevron's Permian Basin holdings alone could represent more than 15% of the company's production portfolio. And that doesn't even include its holdings in the Marcellus shale in Pennsylvania, nor the Duvernay shale in Alberta, Canada. If the company can successful transfer its experience in the Permian to these other shale holdings, this could be a profit pillar for many years.
Still tightening the belt, though
A couple of Chevron's big oil peers have announced that they are starting to increase their capital spending levels to take advantage of lower oil service contract rates, and set up production growth for 2020 and beyond. According to CFO Patricia Yarrington, Chevron isn't quite at that pivot point yet.
Management has been promising its shareholders that it would be cash-flow neutral in 2017 no matter the oil price environment. That was a pretty bold claim at the time, but it is looking like it is a goal very much within reach by the end of the year. One does have to wonder if the company is sacrificing future growth to meet it, though.
What a Fool believes
So here we have a compelling narrative to follow over the next several years. Chevron is still a little behind its peers when it comes to getting back to spending on new projects, but it has an incredible opportunity in the Permian Basin -- and possibly in its other shale plays -- that could allow it to grow production without too much additional spending. It will be interesting to see how these two dynamics play out over the next several years. Fortunately for Chevron, it looks like it will start to make these decisions from a position of strength, in which it has a healthy balance sheet and plenty of cash flow to cover additional spending.
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