Chevron's Current Valuation Belies Significant Political Risks

Sep. 6.12 | About: Chevron Corporation (CVX)

When energy companies have significant accidents, it is always a two-part problem. While accidents are never good for business, the subsequent regulation and public relations fallout many companies face is often worse than the original accident.

The recent fire at Chevron's Richmond refinery was one of the biggest fires in the history of the energy industry. While no fatalities were reported at the company's California facility, the fire was still preventing state and federal investigators from entering the refinery days after starting. Chevron's refinery is also likely to be closed for at least the next six months as investigators begin to analyze what caused this horrific accident.

Chevron (NYSE:CVX) had previously had a fairly strong environmental record prior to this year, with the company having no major public relation disasters similar to the recent BP (NYSE:BP) spill in 2010, or Exxon's (NYSE:XOM) Valdez spill in 1989.

Still, Chevron has had a lot of public relations problems this year, and the company's environmental and public relations problems are coming at the wrong time. While Chevron's recent spill off the coast of Brazil from a rig operated by Transocean (NYSE:RIG) caused minimal economic and environmental damage, the negative public relations from the spill and prosecutor's decisions to subsequently freeze the company's operations in this country was still important as well.

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Chevron's operations in North America face significantly more political risk than its peers because the company's upstream operations are heavily centered in California and along the West Coast. Chevron is headquartered in San Ramon, California, and the company is the largest supplier of gasoline to our nation's most populated state as well.

Several credible reports already suggest that Chevron was likely at fault for the fire, since a pipe that was inspected last year is thought to have burst. Chevron's refinery in Richmond is also one of the oldest in the country.

If Chevron is found to be at fault for one of the largest fires at a refinery in the history of the U.S., just months after the company had its entire operations in Brazil frozen following the offshore spill earlier this year, the political fallout for the company in the upcoming state elections could be significant. California is facing the biggest deficit in the country, and the state has already raised taxes and fees significantly in the last couple of years to avoid having to cut social programs. The democratic governor also recently proposed a new 12.5% tax initiative on oil and gas extracted in California to fund higher education, and the Governor is fighting to have tax initiatives not focused on energy removed from the ballot.

Many leading California politicians have been biased against big oil because of the strong emphasis the state puts on renewable energy and other more natural forms of energy, and Chevron's upstream operations are heavily centered in the nation's largest state. The Federal government is already looking at new taxes on gas and oil companies, as well as raising existing taxes by ending so-called subsidies such as the oil depletion tax, and California will need to raise significant revenues to deal with the state's budget deficit over the coming year. If the recently proposed taxes on oil and gas companies in California are passed, state politicians will almost certainly continue to propose new and more significant taxation levels on energy companies in this heavily indebted state.

To conclude, energy prices have risen over 30% in the last several months, but Chevron's oil production numbers still dropped nearly 7% over the last year. Chevron trades at 8x trailing earnings and 9x a fairly high estimate of next year's likely earnings, but analysts are also projecting single digit growth over the next five years. While Chevron's environmental record had been very strong over the last several decades, the company's recent spill in Brazil and possible negligence in the massive fire in Richmond are coming at the wrong time. With the Federal Government looking to increase taxes and end corporate subsides, and California's Democratic leaders desperate to avoid cutting social programs in an election year, oil companies are an easy target. While Chevron has rallied nearly 20% in the last several months, past performance is not always indicative of future results.

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.