The Rising Influence of Rising Affluence

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Chevron’s Ecuador Woes Mask E&P Potential

http://online.wsj.com/article/SB124837428981176535.html

›JULY 24, 2009
By LIAM DENNING

Chevron's rumble in the jungle creates frisson, but it isn't the main event.

The oil major's stock has trailed its peers since a long-running environmental dispute in Ecuador resurfaced in the media in late April. The possibility that a judge may later this year demand damages as high as $27.5 billion, roughly one-fifth of Chevron's market capitalization, appears to have spooked some investors.

Such fears look overdone. A legal process involving a massive judgment in an Ecuadorean court and attempting to have it enforced in the U.S. would, at the least, take years. The Exxon Valdez saga dragged on for two decades, and the final settlement, after appeals, was about one-tenth the original.

Media coverage as any case drags on would likely pressure Chevron's stock from time to time. But there are more tangible risks and rewards on which investors should focus.

The best-performing oil majors tend either to explore successfully for reserves or buy them cheaply. Chevron has done both.

Sanford Bernstein analyst Neil McMahon said data showing exploration accounted for just 29% of Chevron's reserve additions over the past five years understate the company's record, and potential. Major discoveries such as the Jack field in the Gulf of Mexico and the Gorgon project in Australia have yet to be fully booked as reserves.

In 2005, Chevron bought Unocal's geographically diversified set of assets for just $8.17 a barrel of oil equivalent of proven reserves, according to IHS Herold, just as the energy boom was gathering pace. Compare that with rival ConocoPhillips's 2006 purchase of Burlington Resources near the top of the U.S. natural-gas market, which contributed to a $34 billion goodwill write-down last year.

The upshot is that Chevron enjoys the best near-term growth prospects of any of the majors. Evan Calio of Morgan Stanley forecasts the company will pump 7.7% more oil and natural gas in 2010, compared with last year. Moreover, about nine-tenths of Chevron's incremental output will be oil, offering some defense against the glut of natural gas.

Paradoxically, that growth also speaks to a big risk: project delivery. Deutsche Bank's Paul Sankey points out that rising output is partly from several projects that had missed previous start-up dates and are only now getting going. Moreover, looking ahead, it isn't clear if Chevron can finance the development of its large backlog of projects, while also maintaining big payouts to shareholders.

Barring perhaps Exxon Mobil, that is an issue faced by the entire sector, as is the direction of the oil price. That said, Chevron is favorably placed relative to its peers. Rumbles from Ecuador should provide an opportunity for energy investors to buy in.‹