Although Chevron (CVX) has put up a remarkable defense so far to keep from paying the $18 billion fine ruled by the Ecuadorean court, chances are that Chevron will have to succumb to losing assets in the end.
With the Ecuadorean government mounting the case to a number of jurisdictions, it is likely that this lawsuit will take several years to resolve. As long as there is an appeal, the lawsuit will have a long lifespan. These uncertainties will weigh heavily on Chevron's share price until a settlement is agreed upon. This is a price that Chevron is paying for not accepting the ruling by the Ecuadorean court. Another possible outcome of this lawsuit is that Chevron may have to stop operations in the countries where this case is being heard.
In this article, I will show how the Ecuadorean court case will negatively affect Chevron's long-term value on a discounted cash flow basis.
The Ecuadorean lawsuit kicked off in 1993, when plaintiffs' lawyers filed a case against Texaco, now a subsidiary of Chevron, a case that sought to force Texaco to clean up Lago Agrio oil field in the Ecuadorean province of Sucumbíos where it used to operate. The case also sought to force Texaco to provide proper care for the allegedly affected residents. In 1964, Texaco commenced oil exploration in this oil field. In 1965, Texaco sought to establish a tract by operating a consortium with Gulf oil, which they owned equally. In 1974, the Ecuadorean government took over 25% of the consortium through Petroecuador, the Ecuadorean national oil company. Gulf oil sold its interest to Petroecuador. This meant that Petroecuador owned the majority of the consortium by the 1976.
In 1990, Texaco transferred management of the consortium to the Petroecuador, a concession that expired in 1993. From that time, Petroecuador became the sole owner of the consortium. When Texaco was leaving, it signed a remediation pact in 1995, which was completed in 1998. On completion of the remediation, the Ecuadorean government released Texaco from further liabilities. This pact is one of the weapons Chevron is currently using in its defense.
This case was reignited in 2003, when plaintiffs filed a lawsuit in an Ecuadorean court after Chevron appealed that the case should be held in Ecuador. The case dragged on with many dramas until February 2011, when the Ecuadorean court issued a fine of $9.8 billion against Chevron. The fine was doubled to about $19 billion because Chevron refused to issue a public apology within 15 days. Chevron refused this ruling stating that the process is corrupt and that the plaintiffs are not real.
Since Chevron has no assets in Ecuador, where the $19 billion dollar judgment was handed down, plaintiffs have filed lawsuits in Canada, Argentina and Brazil, where Chevron has assets. This step was taken in an attempt to get Chevron to pay the $19 billion fine. With Chevron refusing the ruling by the Ecuadorean court and the case mounted in other jurisdictions, this case may span through this year and 2014 and possibly beyond.
Impacts On Cash Flow
The severity of this case is expected to have an impact on Chevron's cash flow statement. The third quarter already witnessed a drop in earnings compared to the preceding quarter. I expect this to extend its impact into the fourth quarter results and subsequently into the cash flow statement. The effect of this lawsuit will be absorbed by the impressive results from the first and second quarter results. So the impact of this court case on Chevron's cash flow statement will not be in the extreme.
The fact that plaintiffs are looking to file lawsuits in as many countries where Chevron owns assets worth billions of dollars poses great risk to the long-term future of Chevron's operations. If plaintiffs are successful in enforcing the Ecuadorean court ruling on Chevron, there is a big risk that Chevron will incur "irreparable damage" to its operations.
The more this case affects Chevron's operations, the more its net income and stock will suffer. To see how this affects Chevron's stock, I've brought the chart below. The chart shows the movement of share price from October 1st, 2012 just before Chevron lost the bid to ban the collection of the $18 billion fine to January 13th, 2013.
On October 1st 2012, Chevron was trading around $116. The stock fell sharply on October 10th, one day after Chevron lost its U.S. Supreme Court bid to block the $18 billion fine. Since then, Chevron has been trading at a discount. Another fall in share price happened on the 7th of October just after an Argentine judge called for the seizure of Chevron's assets.
These two instances show just how this case is affecting Chevron's stock. This means that further actions taken against Chevron with respect to this suit will bear weight on its share price. The truth is there are huge chances that more actions will be taken against Chevron. This leaves the fate of Chevron's stock partly in the hands of this suit.
Lawsuits against Competitors
There are no established lawsuits against Exxon as of the end of 2012. The ones available include a fresh lawsuit by Landowners in the aftermath of Yellowstone River oil spill, which will not go to trial until October 2013. Illinois Attorney General, Lisa Madigan and Will County State's Attorney, Jim Glasgow, filed another suit to seek a preliminary injunction against Exxon Mobil. It was alleged that Exxon's refinery released oil into its surrounding in Channahon Township on October 19th, 2012.
These suits do not have footings yet, especially when compared to the lawsuits against Chevron and will not have significant impact on share price. This, in my opinion, indicates that Exxon is doing well to fulfill its corporate responsibilities.
BP (BP), on the other hand, also has a number of big lawsuits against it. The only difference is that BP is getting closer to resolving those major lawsuits against it. I'm stating this with regard to the news that BP agreed to pay a settlement of $4.5 billion to the U.S. government over the immense Gulf of Mexico oil spill, which happened in 2010. However, BP may have to pay more on this oil spill claim.
Chevron reported a net income of $5.3 billion for the third quarter of 2012, which is $2.5 billion lesser than the $7.8 billion reported in the third quarter of 2011. This report shows about a 32% drop from the reported earnings from the same quarter in 2011. This, to call it what it is, is an unappealing result and it has affected the share price. It's even more unappealing when combined with Chevron's legal issues. Comparing these results with those of two of its competitors, you'll see just how poor these results are. ConocoPhillips (COP) reported earnings of $1.8 billion compared to the $2.6 billion reported for the third quarter of the previous year. This figure accounts for about 31% drop. Total (TOT), on the other hand, reported earnings that indicated a 6% rise, compared to the earnings from the corresponding quarter in 2011.
Neither of these results, nor the state of Chevron's legal issues, offers much hope. The only hope is that Chevron has depth in its operations as well as its huge investment in LNG. Further hope is restored by the news of the acquisition of a 50% stake in the Kitmat LNG project and the Pacific Trail Pipeline from Encana (ECA) and EOG Resources Canada (EOG). But this is not enough to justify buying Chevron at this time.