(NYSE: CVX) Chevron’s $54 billion LNG project begins production—why it’s a hot deal for investors
On Mar. 7, oil giant Chevron Corporation (NYSE: CVX) announced it had achieved first production at its Gorgon liquefied natural gas project. On Mar. 20, the company made its first LNG shipment from the Gorgon project, to Japan. This was a landmark achievement for Chevron that may have gone unnoticed by investors because of the overhang caused by low oil and gas prices.
Commodity prices have plunged over the past two years, which has cast a shadow over the immense progress Chevron made at its Gorgon project. While most of the attention gets paid to the oil crash, investors should not ignore the great potential of Gorgon LNG. Even if oil and gas prices stay low for an extended period of time, the fact that this project has finally started producing—thus transforming Gorgon from a use of cash to a source of cash—will be immensely valuable for both the company and its shareholders in the years ahead.
Gorgon: fueling Chevron’s future
Chevron has performed poorly, due to the steep decline in oil and gas prices from their 2014 peak levels. As the price of oil declined, Chevron’s stock price followed suit.
The Gorgon project took several years and $54 billion in financing to complete, but it is finally up and running. Situated off the western coast of Australia, this is truly one of the world’s largest upstream projects. Gorgon itself represents the single largest investment in Australia by a single company or government entity. According to Chevron, the project has three production lines that are set to produce as much as 15.6 million metric tons of LNG per year and enough gas to generate electricity for 2.5 million Australian homes.
Liquefied natural gas could very well be the next growth driver for Big Oil. There is a relative benefit of natural gas as a cleaner source of power than coal, and there is longer-term potential for natural gas as a bridge fuel of sorts to renewable alternatives. In particular, LNG is highly attractive for Big Oil. LNG is much colder than other liquids and 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 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. 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 abundant supply is perfectly situated to serve the rapidly-growing markets in Asia, including China, where demand is high. More than 80 percent of Gorgon’s estimated production is covered by sales and purchase agreements with customers in the Asia-Pacific region.
Don’t underestimate the impact
The completion of the Gorgon project will meaningfully help Chevron’s financial imperative, which is to become free cash flow positive by 2017. In an environment of sub-$40 oil, this is highly impressive. A key part of this initiative is to significantly cut capital expenditures to bring spending in-line with operating cash flow. Indeed, Chevron projects annual capital expenditures in the $17-$18 billion range in 2017 and 2018. For comparison, Chevron spent $34 billion on capital expenditures last year, and $40 billion in 2014. After a multi-year rise in Chevron’s capital expenditures, spending is finally set to taper off now that the company no longer has to invest heavily in constructing these large projects.
Assuming Chevron meets its forecast, it could slash spending by as much as half next year and in 2018. This is expected to provide a huge boost to Chevron’s profitability. On average, analysts expect Chevron’s earnings to soar to $4.75 per share in 2017, up from $1.42 per share forecast for this year. That would represent more than a tripling of Chevron’s profits from year to year. The fact that Chevron is no longer is spending money on building the Gorgon project, and is instead generating revenue from the LNG shipments, is a strong tailwind for the company’s future earnings growth. It is clear the Gorgon project can help restore Chevron’s future profits.
Companies to watch:
Exxon Mobil Corporation (NYSE: XOM): Chevron is operator and the largest owner, but other oil companies have a stake in the Gorgon project as well. Exxon Mobil owns a 25 percent stake. Its revenue and earnings should benefit from the Gorgon boost. Analysts currently estimate Exxon’s earnings to rise 79 percent in 2017.
Royal Dutch Shell (NYSE: RDS.B): Like Exxon Mobil, Shell is a 25 percent owner of the Gorgon project. And, also like Exxon, this project could help Shell’s earnings, which could not come at a better time for the company. Shell’s net profit collapsed 87 percent last year due to collapsing oil prices.
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.