The Rising Influence of Rising Affluence

[DewDiligence]

CVX—Re: Tengiz

You might find this exchange from CVX’s 2Q16 CC noteworthy:

Paul Y. Cheng - Barclays Capital

…question on Tengiz future growth project. Maybe I'm wrong, but my current assumption is that if I have, say, $10 on the transportation cost, and 5% is on the price realization to Brent price, and assume…there's 18% royalty and 30% income tax, it looks like even at $80 Brent, I only get maybe less than 10% internal rate of return for the full project. I just wanted to see whether you can comment on that, whether that internally that you guys looking for a much better return. And if it's $80, why will you sanction the project?

James William Johnson - EVP, Upstream

So I think our economics are a little bit different than yours, Paul. I can't get into details of the fiscal terms that we work under with the contract. But we do see a better rate than what you're seeing. The transportation costs are quite good with CPC. Of course with FGP, some portion of the throughput would have to go by rail. But it's going to be within the envelope of what we've already moved by rail prior to the expansion of CPC. So we're quite comfortable with that.

When we look at…FGP overall, I think there are a couple things in terms of the economics. We have a very good understanding of this reservoir. It's largely been derisked. We've been operating it for 23 years. We have a very strong operating organization and maintenance organization there that's given us very high reliability. So between the good reservoir models and our understanding of that reservoir as well as the operation and reliability we get from the facilities, this is a very good project for us in terms of the scale and the amount of capacity it adds.

We also see that the market conditions right now are favorable and the project is ready for execution. As we've talked about, the engineering is well advanced, over 50%. The procurement is 67%. We have a very good understanding of what it's going to take to execute this project. And we've got a lot of the infrastructure already in place because effectively this builds on the infrastructure that's already in Tengiz. So we see it as a relatively low-risk project from all those factors.

In terms of the opportunities though, we see a lot of upside opportunity. We've done a great job in the past at Tengiz, and we've really got a proven track record of extracting incremental value out of the infrastructure once it's installed. If you look at SGP, for example, the second generation plant, that started up in 2008, this really tested the new technology that's being used at FGP. And since startup, we've been able to increase the capacity of that facility by 22% over nameplate, which gives us a lot of incremental capacity. FGP is actually simpler in terms of the processing facilities than SGP, and we would expect to see similar types of upside opportunity.

There's also upside when you look at the infill drilling that FGP puts in place. And FGP carries incrementally large gas handling capacity, more than what's required right now. So as the reservoir pressures continue to decline, not only does it help stabilize the platform, but we take that additional gas handling capacity and use it on existing facilities today and help handle that increase in gas/oil ratio into the future. So there's a lot of upside benefits that are yet to come. Of course when we talked about the opportunity for contract extensions, we feel this is good for the company as well as ourselves.

Now there are other assessments out there like Wood Mac [Wood Mackenzie]. Many of you may have seen it. There's a number of areas where we see some differences in our view and their view. As I said, we have a very well-matched accurate reservoir model, history match model. We have a faster ramp-up on the project after completion. We also have a faster decline on the reservoir if we weren't doing the project than what Wood Mac is counting on. Both of those would drive value into the project. And finally, Wood Mac has almost twice as many wells in their forecast than we carry in our development plan. So those are some key differences I would point out as well as some of the upside potential we see with this project.

Sounds like a lot of hand-waving to me. Feedback welcome.