Why Saudi Arabia and Chevron Made for a Spooky Halloween in the Petroplex

This morning, being the party animal that I am, I read over the reports regarding the oilfield majors’ earnings announcements yesterday. As one may imagine in a world in which commodity prices (led by petroleum) have been in free-fall for the last twelve months, there was a lot of bad news…

Without (hopefully) diving off into my own T.S. Eliot poem of market despair, I felt that a great deal of the information released publicly by Chevron, in particular, when coupled with the pronouncements of the oil ministers in Saudi Arabia, should inform us about the prospects of the independent producers that make up the lion’s share of production in West Texas. (Was that sentence long? It felt long…)

In short, we have to remember that Saudi Arabia has continually reiterated the importance of maintaining (or even, incredibly, increasing) market share for its product in the world. What is writ large for Saudi Arabia is true also for Chevron – both internationally and domestically. It is critically important for producers and refiners to maintain their share of the petrochemicals market in order to not only sustain cash flow, but to continue to offer value to investors. Those concerns that fail to do likewise do so at their peril.

If we can accept these statements as something approaching fact, the pronouncements made by Chevron yesterday should send shivers up the spine of independent producers in West Texas.

First, Chevron claims that it will increase production by 20% over the upcoming fiscal year… even in the face of falling prices. Why does this make me quake with dread? Well, put quite simply, the major production and refining companies (like Chevron) simply do not have much of a footprint in the Permian Basin. I know… I know… when you’re talking about these kinds of companies, they have a footprint that at least has a shadow on the entire world, but – relatively speaking – the Permian is not a focal point. (Back in the 80’s, when the general assumption was that the Permian was a dying field, the majors couldn’t wait to divest themselves of assets out this way.)

What this means is that they will either: a. swoop in and purchase assets from dying companies in the region, or b. will continue on with development projects in other areas (or countries) already in the works…  As I’ve written in this column before, and argue again here, the open access to debt by local producers means to me that option “b” is the more likely occurrence. The locals will simply hang on long enough, through access to debt, to keep major producers’ focus in other parts of the globe. The conclusion from this assumption is that, despite what the pundits continue to argue, the overall production declines from the local region will be largely swallowed up by the increased production of the majors. This means that the supply glut will continue, unless and until is it exacerbated by the increased production from places like Iran… and Libya… and Iraq.

The second piece of cheery news coming out of Chevron was that they intend to operate at a loss through the end of next year. Again, you may ask “but, Jeff, why is this such a bad idea for West Texas?” Again, I would answer that it relates to what that news forces local producers to do… As the majors do on a macroeconomic level, the independents must follow in a microeconomic exercise. If Chevron, in an attempt to maintain or increase market share or cash flows, keeps pumping, the investors will expect similar tactics from smaller companies. This psychologically… if there is a company that is maintaining its share of the market, while still paying dividends and increasing cash flows, why on earth would you, the sophisticated investor, continue to pour money into a smaller operation with suspended dividends, declining cash flows and reduced market share? You might do so for awhile seeking yield, but your long-term strategy would be to support the established business and pull your investments from riskier bets offering similar returns.

Finally, the message sent to the independents is that, if Chevron, et al. intends to operate at a loss for the next five or so fiscal quarters, then local producers had better open their war chests and prepare for siege. Unfortunately for many of these companies (as, again, I’ve argued before) said war chests have already been emptied by the continued assault on commodity prices. That would ordinarily leave open the possibility that capital markets could play white knight to the beleaguered companies – but these have largely been tapped by the production companies already too…

That leaves debt. Debt, unfortunately, is becoming an increasingly dismal mistress for independents. As I mentioned in a previous post this week, keeping this mistress happy is already eating up to 80+% of cash flows of some of these companies. Eventually this fiscal muse will leave these companies at the alter… then, and only then, will we see a slow turnaround in the market as these “zombies” shuffle off to the great portfolio in the sky.

Unfortunately for West Texas, the last time this happened it took some twenty years to recover…. FORTUNATELY for West Texas, however, I feel that the new production methods will lead to a quicker turnaround. This turnaround, however, cannot begin until we see some capitulation in the local industry. That, I fear, is bound to hurt for the foreseeable future. We’re in for an era of more tricks than treats, I’m afraid.

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13 Responses to Why Saudi Arabia and Chevron Made for a Spooky Halloween in the Petroplex

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