Market Overview

Chevron's Declining Oil Production May Prompt Increased Oil M&A

Chevron (NYSE: CVX), the second-largest U.S. oil company, reported Friday a third-quarter profit of $5.25 billion, or $2.69 per share, compared with $7.83 billion, or $3.92 per share, a year earlier. Revenue slipped to $55.66 billion from $61.26 billion.

On Thursday, rival Exxon Mobil (NYSE: XOM), the largest U.S. oil company, said its third-quarter profit fell to $9.57 billion, or $2.09 per share, from $10.33 billion, or $2.13 per share, a year earlier. Output declined 7.5% Analysts expected a profit of $1.95 a share on revenue of $112.4 billion. Chevron said its third-quarter production fell three percent.

In the case of Chevron, third-quarter production was hampered by a fire at its Richmond, Calif. refinery and the company's idled Brazilian operations. Earlier this year, a Brazilian authorities ordered Chevron to halt production there and various courts in the country have upheld the ruling, leading to a possible legal fiasco for Chevron in the country's that is South America's second-largest oil producer.

Refinery fires and international wranglings are not unusual events for major oil companies to have to contend with. Given that Chevron's production only declined three percent in the quarter, far better than Exxon's output drop, it is not unreasonable to surmise that if the Richmond fire and Brazilian legal woes did not exist, Chevron's production would have been at least flat with the year-earlier period.

Problem is markets are not so forgiving as evidenced by the 2.6 percent decline in Chevron shares Friday. The stock has slid almost eight percent in just the past month. Chevron's production problems may not be as severe as Exxon's. The latter is now riding a streak of six straight quarters of declining output and Chevron is viewed by many investors as the "oilier" play of the two.

Still, there are two factors about Chevron worth noting. First, the company has a massive cash hoard. By some estimates, it was $41 billion earlier this year. Second, there is a chance the company may not be able to operate again in Brazil for an extended time frame. It is likely the company will want to replace that lost output at some point.

Deals, Deals, Deals Oil companies, particularly the cash-rich ones, have an elixir to stem faltering production: Large-scale mergers and acquisitions. That is a road Exxon could certainly travel in its quest to reduce its natural gas profile and boost oil output. Chevron could do the same.

In fact, the company has already been mentioned as a possible buyer for any number of smaller energy firms. At this juncture, it might be just a matter of when and with whom Chevron pulls the trigger.

Practical process elimination of helps reduce the pool of potential Chevron targets. Chesapeake Energy (NYSE: CHK) has been mentioned as a takeover since financier Carl Icahn took another stake in the company earlier this year. Unfortunately for Chesapeake investors hoping for a takeover, two harsh realities exist.

First, not many companies are going to be interested in the second-largest U.S. natural gas producer when gas prices remain depressed. Second, there is almost no need to buy Chesapeake outright when the company is parting with some of its best assets at fair prices to raise cash. No need to buy the cow when one can have the milk as the old saying goes.

To that end, gas-heavy companies such as Cabot Oil & Gas (NYSE: COG) and Range Resources (NYSE: RRC) are not likely to be apples of Chevron's eyes anytime soon.

Three Ideas McMoRan Exploration (NYSE: MMR) is one name that has been mentioned a credible target for Chevron and with good reason. McMoRan is one of the dominant players in the Gulf's Davy Jones prospect, a shallow water ultra deep field in which is Chevron holds a royalty interest. With a market cap of $1.97 billion, Chevron could easily afford a rich premium for the McMoRan.

However, with a large cash hoard at its disposal, there is no need for Chevron to think small when it comes to acquisitions. Earlier this week, a Bloomberg article offered up the idea of Exxon making a move on Anadarko Petroleum (NYSE: APC).

If Exxon, why not Chevron? Anadarko and Chevron both significant African footprints, implying a Chevron buy of Anadarko would make the Dow component one of the largest Western producers on that continent. Additionally, Anadarko's lower risk Eagle Ford and Niobrara shale assets could be a source of allure to Chevron.

Or perhaps Chevron views Anadarko and its African operations and pending Tronox litigation as too risky. It is possible. In that case, the more prudent play would be EOG Resources (NYSE: EOG). EOG is the largest producer in Eagle Ford, a field with multi-billion barrel potential. More attractive still is that Eagle Ford is onshore in the U.S., not offshore in an unfriendly emerging market.

EOG had over 2 billion in proven reserves at the end of last year and the company has consistently raised its estimates for what it can extract from Eagle Ford. Today that number is north of 1.5 billion barrels. Noteworthy is the fact that EOG's five-year revenue growth of almost 21 percent is tops among independent oil and gas producers, including Anadarko.

An analyst quoted in the aforementioned Bloomberg piece said Exxon could have to pay up to $102 a share for Anadarko, which would value the latter at $52 billion. That is an almost 33 percent premium to where the stock currently trades. A 33 percent premium for EOG would value the company at about $41.3 billion. Guess what company has $41 billion?

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