Chevron's Refineries Benefit From WTI Glut

| About: Chevron Corporation (CVX)

Chevron Corporation (NYSE:CVX) posted a 41% increase in net income despite stagnant revenues on the back of increased oil and gas production, relatively better performance in refining - despite the fire at its Richmond refinery at California - and a $1.4 billion gain from an asset swap. Quarterly revenues increased slightly from $60 billion in 2011 to $60.6 billion in 2012 but net income increased from $5.1 billion to $7.2 billion, a record fourth quarter profit. Excluding one-off items, Chevron's EPS came out to $3.27 while analysts were expecting $3.06. Overall, for 2012, Chevron posted its second highest annual profit in its history of $26.2 billion.

The asset swap I mentioned above refers to its deal with the European oil major Royal Dutch Shell (NYSE:RDS.A) in which Shell swapped its two Australian assets for Chevron's interest in the Browse LNG project in Australia. Along with this Chevron has also recently announced its 20th discovery since 2009 off the coast of Western Australia. The Kentish Knock South-1 discovery well encountered 75 meters of net gas pay at the WA-365-P area which is jointly operated by Chevron (50%) and Shell (50%).

However, production remains a concern as no significant gains were made overall in 2012, not even in the U.S. The company's output in the final quarter increased by 6.8% sequentially to 2.67 million barrels of oil equivalent per day but has remained fairly flat year over year. For 2012, Chevron produced 2.64 million barrels of oil daily in 2012, down slightly - 1.12% - from 2.67 million barrels per day in 2011. The slight decline can be attributed to the suspension in production activity at the Frade field in offshore Brazil, which will likely cost the company significantly in cleanup costs and damages. An $11 billion lawsuit has been filed.

Meanwhile in the U.S, when compared to the Department of Energy's latest report on crude output for the fourth quarter, Chevron's output lagged behind significantly, 3% versus total production increases of 14%, averaging 462,000 barrels per day. Given that the spread between Brent and West Texas Intermediate continues to hover near the $20 level, Chevron's international exposure puts it currently in a very good position versus other majors like Exxon-Mobil (NYSE:XOM) whose production has become more dependent on the U.S. and Canada.

Case in point, Chevron's Q4-2012 average selling price was $91 per barrel in the U.S, down 9.9% from last year, and $100 per barrel in the international markets, down just 0.99% from last year. The international demand for oil will continue to absorb the slowing U.S. import demand. This may not translate into rising Brent prices, ex currency effects, but it will do nothing to solve the infrastructure problems beginning to plague domestic producers.

Where Chevron's U.S. business is performing well is in its downstream operations, where the company recorded earnings of $331 million, significantly better than the loss of $204 million recorded in the same quarter last year. Even though production totals were flat, declining input costs and higher output prices caused an increase in margins. The Richmond fire caused a drop in crude input by 61,000 barrels per day while refined product sales fell by 6.1% to 1.15 million barrels per day. Similarly, international downstream earnings have also increased by 315.38% to $594 million despite falling input and flat output volumes.

Meanwhile, Exxon Mobil posted similar results on the back of strong performance of its refining arm while a rise in wellhead output remained challenging. The company's profit increased from $9.4 billion a year earlier to $9.95 billion while income from refining quadrupled to $1.77 billion. Exxon also benefited from low-priced Canadian crude. Like Chevron, Exxon also managed to beat analysts' estimate by posting $0.21 higher earnings of $2.20 per share.

In the last twelve months, shares of Chevron have increased by 9.9% while those of the more conservatively managed Exxon are up 5.6%. Chevron offers a relatively higher yield, has a lower P/E and has generated greater earnings per share in the last twelve months. But Exxon is a safer stock with a lower beta that gives a greater return on equity. In this low-growth global environment to see oil and gas companies posting record profits on rising prices tells you that this is a monetary inflation-driven trend, not a fundamentally strong one. Yes, overall demand for oil and gas continues to increase thanks to emerging markets, especially Asia-Pacific, but the prices paid are not rising on the industry's inability to meet rising demand, which is what would normally move price, but rather a rise in the overall flow of dollars through the oil market.

Fundamentally and as an inflation hedge I have liked the major oil and gas producers as a part of the backbone for a balanced portfolio that provides a relatively low beta means to seek solid yield.



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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.