FreightWaves Oil Report: A Big Writedown By Chevron Doesn't Signal The End Of The Oil Era

An enormous writedown by Chevron Corporation CVX this past week on the value of mostly North American assets could be viewed, in an odd way, as a tremendous sign of success.

Chevron wrote down between $10 billion and $11 billion in assets. It was believed to be the largest writedown in recent energy industry history, and it set the usual social media crowd abuzz with warnings that it was yet another sign of the end of the hydrocarbon age, with renewables continuing to push aside old-line sources of energy.

Chevron's writedowns were overwhelmingly focused on its natural gas assets, not its crude oil or refining activities. The underlying reason for the writedown was that the U.S. keeps pumping out massive quantities of natural gas far in excess of its ability to find new markets domestically or, more importantly, in other countries through exports of liquefied natural gas (LNG.)

U.S. gross withdrawals of natural gas, which is the best figure to measure production, were 112.8 billion cubic feet/day in September, the last month for which the Energy Information Administration has full-month data. A year ago, it was 104.7 Bcf/d. Two years ago in September, it was 92.1 Bcf/d. 

And this has happened even as the North America gas-specific rig count reported by Baker Hughes has dropped from just under 200 two years ago to about 135 today.

A year ago, the price of natural gas at the Henry Hub benchmark was about $3.75/Mcf/d. Today's, it's about $2.30 and the trend has been down all year.

Chevron therefore was confronting the reality of the petroleum industry's ability to get more and more natural gas (and oil) out of the ground using fewer and fewer wells. That's why its writedown can be seen as a success story.

But if we're transitioning to a new energy future, shouldn't consumption be going down? Isn't that part of the natural gas industry's problem?

Here are the numbers: The U.S. consumed about 85.8 Bcf/d this year, according to the EIA. Next year, the agency said, it will be about 87.2 Bcf/d. In 2016, it was about 75 Bcf/d, a rise in consumption that has been driven to a large degree by the shutdown of coal-generating plants and their replacement with generation facilities powered by natural gas.

That's why the Chevron writedown should not be seen as signaling the end of any sort of hydrocarbon era. You could make a theoretical argument that the increase in consumption in the U.S. would be a lot higher if renewables hadn't made significant inroads into the production of electricity. But the numbers don't back that up to any significant degree.

Let's take July, a peak month for solar generation for obvious reasons and a peak electricity consumption month because of air conditioning. According to the EIA, solar generation in July jumped to 8 million kilowatt hours from 6.7 million Kwh between 2018 and 2019. Electricity from natural gas? It went up 9 million Kwh.

Gas is still hot. But for Chevron, there's still just too much of it.

"The approximately $10 to $11bn of asset write-downs is concentrated in dry gas assets in the Marcellus (over 50%) and Canada, two areas the investment community does not want Chevron (or pretty much any industry participant) to invest in given North America's oversupplied gas market," Wells Fargo said in summing up the company's decision. Dry gas is gas that is produced without associated gas liquids, such as propane and butane. The prices received for those products, which are considered to be petroleum rather than gas, are often the difference between a profitable well and one that produces red ink. Dry gas doesn't have that benefit.

(Part of the writedown was for a deepwater Gulf of Mexico 75,000 b/d project called Big Foot, which launched last year. Beyond its high costs, Big Foot crude has a profile that is not great in an oil market that is cutting sulfur in IMO 2020 and in Tier 3 gasoline next year: It has a sulfur content of 2.7%. The IMO 2020 limit is 0.5% and Tier 3 is tighter than that.)

The announcement of the writedown came from Chevron when it announced its capital expenditure budget for 2020. It will be about $20 billion for the third year in a row, and while gas may be taking a big hit on its valuations on Chevron's balance sheet, there's still a decent amount of investment for some of the company's oil projects, including spending aimed at the Permian Basin in the U.S., and the company's big Kazakhstan investments where it has been a leader since pretty much the fall of the Soviet Union and the rise of Kazakhstan as an independent state. The Permian is getting about $4 billion in spending, Chevron said.

The Wall Street Journal addressed what might be considered the "other" reason for the writedown: a world said to be moving away from oil and gas. "The sobering reappraisal by one of the world's largest and best-performing oil companies is likely to ripple through the oil-and-gas industry, forcing others to publicly reassess the value of their holdings in the face of a global supply glut and growing investor concerns about the long-term future of fossil fuels," it said in its reporting on the Chevron move.

But Chevron's announcement said nothing about part two of that observation, the "investor concerns." The energy team at Bank of America Merrill Lynch, for example, did not refer to that sort of long-term concern in reviewing the Chevron decision.

It is true that oil and gas stocks have lagged the market severely in the past year. Chevron's stock over the past 12 months is down 6.4%. The S&P 500 is up more than 18% during that time. How much of that is because oil prices are weak and how much is because of the long-term concern about oil and gas demand can't fully be ascertained.

The biggest worry Merrill Lynch expressed was that the company continue to generate enough free cash flow to keep paying its current dividend, which carries a yield of more than 4%.

That's one thing oil companies can do to keep investors: keep paying a healthy dividend. (ExxonMobil's yield is around 5%.) Restraining capital spending and not pouring it into producing more natural gas in a market flooded with it is one way of accomplishing that … which is what Chevron did this past week.

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