Chevron: Building Assets For Tomorrow

Chevron (CVX) recently went into a joint venture with Polskie Górnictwo Naftowe i Gazownictwo, or PRNiG, to explore the shale formation in Poland. The joint venture is a 50-50 partnership between the two companies. This joint venture would operate with four licenses for exploration in southeastern Poland; two of these licences are held by PGNiG and the other two are held by Chevron. The four licenses are held for the regions of Tomaszów Lubelski and Wiszniów-Tarnoszyn from PGNiG; and Zwierzyniec and Grabowiec from Chevron. These companies plan to start commercial production by 2015. The shale gas reserves in Poland could be as high as 768 billion cubic meters.

While there is large reserve to recover, much technology is needed to develop those reserves. The cost of drilling a well in the Polish shale is around $15 million, which is higher compared to the cost of drilling wells in the U.S. shale formations. For example, a well drilling in the Barnett shale costs around $4 million. In Poland there are 50 exploratory wells drilled in the shale formation. Since Poland's shale formations have a complex structure of rock formation, around 200 to 300 wells are required to determine the structure and potential reserve of the shale formation, and hence it involves a major exploration cost. To recoup this huge exploration cost, Chevron needs to achieve high economies of scale. Production requires around 500 new wells to be drilled annually. The high cost of drilling wells and low production rates forced companies such as ExxonMobil (XOM) and ConocoPhillips (COP) to exit Polish shale formations last year. This year also saw the exit of companies such as Talisman Energy (TLM) and Marathon Oil (MRO). This is a significant challenge for Chevron to produce economically from the Polish shale formations. The joint venture with PGNiG will help Chevron reduce the risk of its exploration cost as the capital commitment will be shared between the two companies.

The Polish government is trying to reduce its country's energy dependency from other countries. Shale gas exploration is a major step in that direction. Around 67% of Poland's natural gas demands are met through imports, and around 80% of these imports are from Russia. Last year, Poland consumed around 16.6 billion cubic meters of natural gas, and around 9 billion cubic meters was supplied by Russia. Though its demand is met through the Russian supply, Poland pays $500 for 1,000 cubic meters of natural gas, one of the highest prices in Europe, giving it incentive to develop its natural gas resources. The Polish government plans to invest around $16.9 billion in the shale gas sector by 2020. Earlier this year the Polish government provided tax incentives for oil and gas companies to make shale exploration attractive. The tax law for shale gas extraction is expected to go into effect from 2015, and the government won't levy any taxes on the production from shale formation until 2020. This shows that it is trying to create a more conducive environment for shale exploration that could help Chevron to continue its operation in Poland.

The capex spirals

Chevron has revised the capital expenditure of its Gorgon LNG project in Australia. The capex of the project spiraled from its initial estimation of $37 billion in 2009 to around $54 billion this year. Chevron's total capital spending for this year is expected to be around $42 billion, moderating at around $39.8 billion next year. Compared to Chevron, the planned spending of ExxonMobil, which holds around 25% in the Gorgon project, is expected to be roughly $41 billion this year. The Gorgon project is 75% complete and expected to start production by mid-2015. A part of the increase in the capex budget of Gorgon is the cost of labor in Australia. The inflating labor cost is due to lower labor productivity in Australia compared to in the U.S. and Canada. Compared to the U.S. Australia takes about 30% more time to complete construction work. Further, the Australian labor rates are 20% to 30% higher than U.S. construction labor counterparts. Labor cost could therefore further increase project costs in the coming quarters. Lower labor productivity adds around $0.2 per million British thermal units to Australian natural gas compared to Canadian natural gas. However, it is expected that the capital expenditure on the project will peak in 2014 as it nears production.

While there is a capex increase of the Gorgon project, its completion is crucial to Chevron as it will boost the company's production output. This project, which has a natural gas processing capacity of 15.6 million tons per annum, is likely to make the company a major supplier of LNG in the Asia-Pacific region. With a share of around 47.3% in the project, Chevron could add 70.32 million barrels of oil equivalent, or mboe, per annum. This is around 193,000 barrels of oil equivalent per day, or boepd, of production. By 2017, Chevron plans to produce nearly 500,000 boepd of LNG, signifying the importance of the Gorgon project to achieve this target. Completion of it will boost the company's cash flow.

Building the assets is a prime focus

Chevron has ventured into the Polish shale gas formation when the government is trying to create a conducive environment for shale exploration. In addition to this the company's joint venture will provide a cover for the exploration risk in the Polish shale formation by reducing the capital requirement required.

The Gorgon project continues to play a central role in the company's goal of future LNG production. In an environment where labor costs are high, the company might further experience increases of its capex for the project. However, the capex will subside as the project goes into the production phase. As the capex for this project continues to decline next year after reaching its peak, and production kicks in, Chevron stands to recuperate its costs and create cash flow for investors. I recommend buying this stock.

Source: Chevron: Building Assets For Tomorrow

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. (More...)

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