Take A Wait And See Approach With Chevron

| About: Chevron Corporation (CVX)
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In recent remarks, David O'Reilly, CEO and chairman of Chevron (NYSE:CVX) until January 2011 and now chairman of the National Petroleum Council, indicated he is betting against U.S. oil independence based on shale extraction. O'Reilly said, "I do believe that we will still be importing oil 20 to 25 years from now, and that is one area of vulnerability we have in our supply system," citing weakness in the current infrastructure and a lack of economic scale. O'Reilly's view partly explains why Chevron is moving slowly on entering unconventional plays in the lower 48 states, which I believe is ultimately to Chevron's detriment.

Chevron's reluctance to participate in shale plays puts it behind all of its U.S. based competitors. Marathon Oil (NYSE:MRO) is betting heavily on shale to fuel its growth. Exxon Mobil (NYSE:XOM) is now the largest producer of natural gas in the U.S. following its acquisition of XTO Energy in 2009. It was not until February 2011 that Chevron acquired Atlas Energy to obtain its first foothold on U.S. shale gas, though the deal was nowhere near as large or as successful as Exxon Mobil's acquisition of XTO. As of the end of 2011, Chevron owned 700,000 acres in the Marcellus and 600,000 acres in the Utica, but is apparently not very excited about the prospects here as these plays are not even mentioned in the company's first quarter earnings presentation.

If Not Drilling in the U.S., then Where?

Chevron's strongest area of focus remains its natural gas projects, primarily centered in Australia, where it operates the Gorgon and Wheatstone projects, among others. Outside Australia, Chevron's operations are fractured, with smaller development and production activities across the globe. This lack of focus is leading to pitfalls for Chevron, as several of its vaunted future projects are put on hold.

Hydraulic fracturing is receiving more scrutiny in Europe than it is in the U.S. France, for example, outright banned the process. Chevron decided to put its focus on shale gas in Romania, but it appears that its exploratory drilling in this area will need to be put on hold until at least 2013 as Romanian Prime Minister Victor Ponta announced he wants to halt shale exploration projects until next year, pending completion of an environmental impact study.

Chevron's plans to re-start production in the Frade field off the shores of Brazil are also on hold, as Brazil's chief oil regulator is requiring the company to explain how it will "mitigate" future problems on its fields after a small November spill that ultimately dispersed.

Chevron is also indicating that it plans to invest in Myanmar, due to recent indications from the U.S. government that restrictions preventing companies from doing business with the country might be eased. Chevron's interest in Myanmar's oil and gas resources is not new; the company is participating through one of its subsidiaries in a joint venture led by Total (NYSE:TOT) that produces natural gas from the Yadana gas field and operates a natural gas pipeline. On its website Chevron indicates that it "continues to support the calls for a peaceful resolution to the issues facing Myanmar."

Myanmar is making progress, as last year the military junta ceded control of the country to a civilian led government. However, recent reports indicate that beneath the surface nothing is changing, and the military continues to control and profit from the nation's oil and gas industry. Myanmar's Energy Ministry estimates that natural gas reserves in the country could come in at 22.5 tcf, which helps explain why Chevron is eager to take this risk. However, the current political situation in Myanmar is all too similar to the situation that rocked Libya last year and is forcing majors like Shell (NYSE:RDS.A) and Occidental Petroleum (NYSE:OXY) to pull back from Libyan operations. Nonetheless, Chevron seems determined to press ahead.

Despite Chevron's focus on international shale exploration, the company is taking a cautious approach, with Vice Chairman George Kirkland indicating that "the speed at what people speculate shale gas will be coming to market is faster than what reality will actually show." Kirkland points to several factors, not least of which is the fact that compared to plays in the U.S., shale geology in other countries is less explored and consequently less developed. Kirkland believes the infrastructure in the U.S. is also better developed, though companies operating in the U.S. that are being forced to develop their own infrastructure to support production might argue with this point. Exxon Mobil CEO Rex Tillerson also believes that development in other countries will move more slowly than in the U.S. The difference between Exxon Mobil and Chevron here is that Exxon Mobil is hedging itself with U.S. production, and Exxon Mobil is not counting on international shale gas for growth.

On the Legal Front

Chevron is losing support from all corners in its bid to toss $18 billion in damages assessed over legacy activities in Ecuador. On June 12, the D.C. Circuit of Appeals ruled that Chevron cannot have access to privileged documents owned by the Ecuadorian plaintiffs in the case. Chevron sought the documents in order to prove its allegations of fraud by Ecuador, which allegations were repeatedly denied by lower courts. Chevron's institutional shareholders made it clear in the company's annual meeting last month that a settlement is the preferred course of action, as it appears increasingly unlikely that Chevron will be able to avoid paying out a significant portion of its available cash over this lawsuit.

Chevron's continuous insistence that fraud was involved in this case is catching the attention of regulators. U.S. Congresswoman Rep. Jan Schakowsky asked the Securities and Exchange Commission to review Chevron's activities in the case for possible violations of securities laws. Schakowsky's letter follows similar requests from several of Chevron's institutional shareholders. Although I believe it is in Chevron's best interests to settle the suit, this may represent a huge hit for the company, which I think could force its price per share as low as $80, a level not seen since 2010.


Chevron is currently trading around $101 with a price to book of 1.6 and a forward price to earnings of 7.5. As I mentioned above, I think that the price could fall dramatically once a settlement with Ecuador is reached. The question is when Chevron will reach that inevitable conclusion, as it could be months or even a year from now. If the SEC decides to move on requests to investigate, Chevron may well speed up the proceedings, but at that point additional damage will be weighting the company down. For potential shareholders of Chevron, a wait and see approach is best.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.