As someone interested in making long-term investments, I have always had a special fondness for Exxon (XOM), Chevron (CVX), and Conoco (COP) because the management teams at all three companies seem to "get it" when it comes to rewarding shareholders with dividends and making capital allocation decisions that think in terms of decades, rather than the quarter-to-quarter rigmarole that focuses on short-term results at the expense of long-term wealth building.
Of course, not everyone in the market thinks that way. This release from Reuters last week demonstrated the unease with a certain block of the Chevron shareholder population that didn't seem particularly pleased with Chevron's ongoing commitment to spend $40 billion per year in capital expenditures to grow volume production:
Chevron Corp plans to keep spending roughly $40 billion per year for the next several years on new oil and natural gas projects in a bid to lift production that is on track to be flat for the third straight year. That stay-the-course approach, announced on Friday after the second-largest U.S. oil company said its quarterly profit dropped 32 percent, spooked investors and prompted the stock to fall 3.5%, the most of any large energy producer this quarter.
From my vantage point, the CEO John Watson is proving himself fit for the office of the CEO leadership position by resisting calls from analysts and investors in the industry to take the Royal Dutch Shell (RDS.B) approach of scaling back capital expenditures to temporarily boost profits in the 1-5 year stretch.
Based on his actions, Watson seems to understand the arc of Chevron's story: the current replacement rate of reserves for Chevron is in the 94% range, and you want to get that figure up above 100% over the long-term so that you are bolstering mineral and oil assets, rather than depleting them.
In 2013 and probably for 2014 as well, Chevron has been pumping out the equivalent of 2.6 million barrels of oil and oil equivalents per day. The point of these large capital expenditures is to (1) get the reserve rate above the sustainable 100% threshold for the long-term, and (2) to grow production by half a million barrels of oil and oil equivalents per day once the liquefied natural gas projects in Australia go live and the slightly smaller projects in the Gulf finally start adding meaningfully to the company's production.
Adding half a million barrels of oil (and equivalents) to production in the next 4-5 years is a big deal; that's an increase of 20% in production that should be a nice benefit to shareholders, without even taking into account the effects of dividends, buybacks, increased efficiencies, and favorable changes in the prices of commodities that could benefit shareholders come 2018 or so.
The reasonable concern about Chevron's extensive projects is that the company generally spends more than its peers in finding costs for each barrel of oil; for instance, Chevron typically spends a little over $5 in finding expenses for each barrel of oil compared to the industry average of its peers which is a little below $4 per share-that 20% spread has been a historical obstacle that Chevron has historically been able to blow through with ease.
That is because the company is out there dedicating its efforts to growing profits by achieving actual honest-to-god growth in the business, as opposed to the strategy at Exxon of growing a bit and retiring massive blocks of stock.
When you look at the numbers since 2003, you can get a feel for how Chevron relies much more on profit growth from expanded operations rather than buybacks. In 2003, Chevron had 2.138 billion shares outstanding. Now it is at 1.93 billion. The growth has come from a reliance on increases in total profits, independent of buybacks: the company's overall profits have grown from $7.2 billion in 2003 to $21 billion at the end of 2013 (for comparison, Exxon increased its profits from $17 billion to $32 billion over the same stretch, but reduced its share count from 6.5 billion to 4.3 billion to complement growth). It is the result of heavy capital expenditures and an ongoing commitment to volume growth that explains why Chevron has been able to triple profits since 2003.
It seems that concerns about Chevron's $40 billion annual capital expenditures is mostly a case of "short termitis" among members of the energy investment community, and CEO Watson is acting in the long-term interests of shareholders by resisting the call to scale back spending. The same analysts that don't like the extensive capital expenditures now will probably be touting Chevron as an investment in 2017 and 2018 when these projects go live and they start reporting extensive advancements in the growth of volume production. For those of you that make investment commitments in terms of decades rather than months, you should be impressed by the strategy at Chevron and be glad to have John Watson as a steward of your capital.