For the first time in 2014 West Texas Intermediate's "WTI" crude prices broke $100 per barrel. Movement in crude prices largely affects the valuation of the oil producers. Higher prices cause oil producers to spend more on drilling so that the revenues of the company can increase. Therefore, investors who own energy stocks use WTI prices as major indicators of industry trends. Therefore I believe that companies like Chevron Corporation (CVX) will take advantage of this hike in price as the company is the second largest in the sector. Let's have a look at the industry analysis and the company's growth prospects in order to determine what Chevron has in store for investors.
Future of Energy
Oil and gas will likely have limited demand growth in North America and Europe over the next few years owing to slow economic recovery in these regions. Most of the marginal growth in both oil and gas will arise from emerging market economies such as China and India. China's annual oil and gas consumption are set to rise by around 9% and 23%, respectively. Thus, the effect of the high demand for oil and gas in emerging economies can be seen in the bottom line of companies operating in the industry.
The world's real gross domestic product "GDP" will rise by an average of 3.6 percent per year from 2010 to 2040. Emerging countries outside of the Organization for Economic Cooperation and Development (OECD) will experience a combined GDP growth of 4.7 percent per year. In the OECD regions, GDP will grow at a much slower rate of 2.1 percent per year until 2040 due to more mature economies and slow population growth trends. Strong growth in real GDP of non-OECD countries will drive the fast-paced growth in future energy consumption. Therefore, I believe the soaring demand for energy will ultimately contribute to the higher margins of the industry.
From 1990 to 2010, China and India were the fastest growing nations with annual GDP growth rates of 10.4% and 6.4% per year, respectively. Although the Western economies exhibited sluggish growth prospects global oil consumption is expected to be boosted from sustained strength in China, the Middle East, Central and South America at a healthy rate.
The following graph explains the trend of energy consumption in recent years and the projection of energy consumption over the next three decades.
According to the Energy Information Administration "EIA," world crude consumption grew by an estimated 0.7 million barrels per day in 2012. The agency, in its most recent short-term energy outlook, said that it expects global oil demand will grow by another 1.1 million barrels per day in 2013 and a further 1.2 million barrels per day in 2014. On the supply side, the agency expects that the global supply of oil is likely to go up by 0.8 and 1.2 million barrels per day this year and in 2014. Therefore, I believe oil prices should increase in both the short and long run and Chevron will able to capitalize on this increase in oil price and reflect it in its margins.
As far as natural gas is concerned, prices vary from $0.75 per thousand cubic feet in Saudi Arabia to around $12 in Europe and as high as $16-17 in Japan. In the United States natural gas price fluctuates between $3 and $4 per thousand cubic feet. Therefore, I can conclude that natural gas prices have been more competitive overseas in comparison to the US which is a positive sign. This price difference can help Chevron to extract profit from those regions where the price of natural gas is high.
With regards to Chevron's growth prospects, the company's crude oil and natural gas liquids segment is more profitable than the other segments of the company. Although the revenues from the production of crude oil and NGL are less when compared to its downstream business, the profitability is much higher. The difference in margins is primarily driven by the low cost of production for crude oil. Since the margins of the downstream business are low the company is reducing headcount in the downstream business and focusing on the more profitable business.
The downstream business' EBITDA margin was nearly 4.4 percent in fiscal year 2012 while its upstream EBITDA margin was a bit higher from 37 percent in fiscal year 2012. Therefore, I believe that the company will continue to focus on its higher margin business segment in the future.
On an aggregate basis, energy consumption is expected to increase over the next three decades. Therefore, I believe the crude oil price should surge in the end as a result of increasing demand for oil in resource hungry economies. Owing to the increase in crude oil prices I believe that the margins of the company's upstream segment will increase in the future.
Moreover, the company is focusing on segments that are more profitable and cutting the headcounts in the less profitable segments in order to curb costs. Therefore, I believe that the company's margins will improve in the future and I see Chevron as a decent buying opportunity for investors.