Chevron's Upstream Production Outlook Supports $145 Value

| About: Chevron Corporation (CVX)
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We recently revised our price estimate for Chevron (NYSE:CVX) to near $145. Our valuation adjustments were primarily based on the positive upstream production outlook as well as stable long-term growth seen in crude oil and natural gas prices. Chevron generated more than $230 billion in revenues during 2012 while net earning totaled more than $26 billion. The shares are trading around $125 currently.

California-based Chevron is the second largest energy company in the U.S. after Exxon Mobil (NYSE:XOM). The company manages its investments in subsidiaries and affiliates for which it provides administrative, financial, management, and technological support to its U.S. and international subsidiaries engaged in fully integrated petroleum, chemicals, and mining operations as well as power generation and energy services.

What's Fueling Chevron's Growth?

Like all the other integrated oil and gas companies, Chevron generates most of its cash flows from its upstream division that is primarily involved in exploration and production (E&P) activities. According to our estimates, crude oil and natural gas E&P operations make up more than 40% of the company's valuation.

The upstream division's valuation largely depends on new discoveries of commodity reserves and ongoing projects that will boost production and price realizations. Chevron's upstream division has bright prospects as the company expects to boost its oil and natural gas production by more than 20% by 2017, over its 2.6 million barrels of oil equivalent (BOE) per day produced in 2012.

Natural gas production will be boosted primarily by its ongoing projects in Australia. Chevron has been spearheading the development of natural gas in Australia with around a 47% stake in the Greater Gorgon Area, the country's biggest domestic source of the natural resource. Its mega-scale Gorgon Project, which is expected to produce more than 450,000 BOE per day at full capacity, includes 8.9 million metric tonne per year liquid natural gas (LNG) facility. The LNG facility will ensure easy transportation of natural gas to the fast growing Asian economies. Scheduled to begin operations in 2014, the project forms the centrepiece of Chevron's production volume ramp-up plan. Apart from Gorgon, the company also has significant interests in other large scale, upcoming projects in Australia such as Wheatstone and Browse. Recent oil well discoveries in the ultradeep waters of the U.S. Gulf of Mexico are also expected to boost oil production volumes going forward.

As far as price realization is concerned, at least for oil, we forecast prices to increase at a very conservative 2.5% CAGR over the forecast period in contrast to almost 15% CAGR seen in the Brent Crude prices since May 2003. This is because we believe rising oil production in the North American region, mostly coming form unconventional sources such as shale oil in the U.S. and oil sands in Canada will increase oil supply from non-OPEC countries significantly, to reduce pricing power long held by the OPEC countries. We are not ruling out negative supply shocks might increase oil prices and volatility in the short run. However, long-term fundamentals appear to have swung positively for a much smoother demand-supply equation than seen in the past. According to the IEA's latest report, U.S. production is likely to grow by almost 3.9 million barrels of oil per day by 2018, which will change it from the largest importer to a net exporter of oil.

Most of the incremental demand fueling higher prices is seen coming from the emerging economies such as China and India, where growing population and rising income levels make a solid case for higher energy requirements. Rising demand from these economies is expected to more than offset declining consumption seen in the European countries.

We also expect natural gas prices in the U.S., which touched a bottom of $2 per 1,000 cubic feet in 2012, to increase in the long run backed by increasing demand from industrial and power sectors in the U.S. Recently approved export plan of natural gas from the U.S. to other countries in Europe and Asia, where natural gas prices are more than double than that in the U.S., is further expected to fuel higher average price realized by Chevron from the sale of natural gas.

Disclosure: No positions.