Will This Big LNG Bet Pay Off?

Jordo is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Chevron (NYSE: CVX) recently reported two new natural gas discoveries off the coast of Australia – The Pinhole-1 and The Arnhem-1.

This brings the number of Australian natural gas discoveries for Chevron to 19 in the last three years. George Kirkland, Chevron’s vice chairman, said “Chevron Australia’s ongoing success offshore of Western Australia is a result of our long-term commitment to exploring and developing the region. The Carnarvon Basin is a world-class hydrocarbon basin, and these discoveries underscore the quality of our Australian portfolio and our technical competence." These discoveries play into Chevron’s long-term plan to focus more on rapidly industrializing Asia and less on Europe and North America, where economic growth and energy demand is stagnating. Prior to this discovery, Chevron had announced the $43 billion Gorgon natural gas project along with a $29 billion Wheatstone Australian natural gas project. 

Chevron has invested a large sum of money in Australia because it plans to supply natural gas to customers in Australia and the Asia-Pacific region. Most of the new production is targeted at Asian economies, where demand for natural gas is expected to show a sharp growth over the next few years. Its biggest customer will be Japan were natural gas prices are around 16.5, close to 5 times higher than in the United States. Japan is the biggest importer of natural gas in the world, and its demand for natural gas has increased as a result of the 2011 Fukushima earthquake that put some of its nuclear reactors off-line. Chevron has already inked a number of LNG sales with Japanese companies. It has already managed to sell 3.1 million tons of LNG annually to Tokyo Electric Power and 800,000 tons of LNG a year to Kyushu Electric Power.

Chevron Eyes North American LNG

While Chevron still has big plans for development in Australia, it recently turned towards developing and exporting LNG from North America. Chevron announced that it would buy into Canada’s Kitimat LNG project along with Apache (APA) from Encana (ECA) and EOG Resources (EOG). Chevron plans to transport relatively cheap North American natural gas to Asia-Pacific customers. Kirkland said, "It is ideally situated to meet rapidly growing demand for reliable, secure, and cleaner-burning fuels in Asia, which are projected to approximately double from current levels by 2025.” 

The Kitimat project has had nothing but problems, and Encana and EOG finally bowed out after they were unable to find secure offtake customers in Asia. Chevron also has problems in Australia in the way of massive cost overruns.  It is my belief that the company made big bets in Australia and Canada with the hope of selling cheap natural for high prices in Asia, because they had no other avenues in which to increase revenues. In North America and Europe economic growth is flat. As a result of new extraction methods, North American oil prices are flat and natural gas prices are low.

Chevron’s price to earnings growth ratio (PEG) is 902 because its earnings are slowing. That compares to BP (NYSE: BP), ExxonMobil (NYSE: XOM) and ConocoPhillips (COP), with PEG ratios of 4.38, 3.83 and 1.92 respectively. Chevron's profit margin of 10.7% is still higher than BP at 4.75%, Exxon Mobil at 10.4%, and ConocoPhillips at 4.5%, but without some sort of catalyst, that advantage might not last. 

BP was downgraded by RBC Capital Markets to Sector Perform due to limited upside in its target price and the potential for near term risk. Islamist militants recently attacked the In Amenas plant jointly operated in eastern Algeria by BP, Statoil (STO), and state oil company Sonatrach. BP is not sure when operations at the plant will continue.

Meanwhile, ExxonMobil announced that it will develop the Hebron oil field offshore the Canadian province of Newfoundland and Labrador. Exxon plans to recover over 700 million barrels of oil, which is up from previous estimates. Exxon expects to begin production in late 2017. The Hebron oil field is designed for daily output of 150,000 barrels. 


Chevron, the second-largest U.S. oil company, said its fourth-quarter profit would be "notably higher" than the previous quarter as oil and gas output bounced back and it booked a $1.4 billion gain on an asset transaction. The company also announced that it is close to bringing its refinery in Richmond, California back on-line. The refinery, which processes 245,000 barrels of crude oil per day, was put out of operation by a fire on August 6th. 


Chevron could be forced to deliver more bad news about its Gorgon gas project on top of yesterday's announcement that costs at the company's massive liquefied natural gas venture in Western Australia have blown out by $9 billion to $52bn thanks to a soaring wages bill, logistics problems, and bad weather. The additional bad news was that the projects first LNG target date was pushed to the first quarter of 2015, from a previous date of late 2014. 


Chevron has made a big bet by investing in LNG facilities in Australia and Canada. The idea was to enter into the Asia-Pacific market and increase revenues and net income (In the third quarter Chevron’s revenues were down by 10% and its net income was down by 45%). Unfortunately, the progress of both of these projects has been slow. Neither the Australian facility, nor the Canadian facility is likely to begin shipping LNG before 2015.

That brings me to Chevron’s bigger problem.

The main reason for developing these projects was to take advantage of the high selling prices for natural gas in Asia. However, in recent months, Asian companies have been stepping up the pressure to buy natural gas at reduced prices. For instance, Japanese firm Kansai Electric made a deal to buy LNG at the much lower U.S. Henry Hub price. This development could be a blow to Chevron’s plans for the future. If they were forced to sell natural gas at the Henry Hub rate their margins (operating margin 15.7 and profit margin 10.7) would be negatively affected. The jury is still out on Chevron’s big bet, but from my point of view, it does not look good.

jordobivona has no position in any stocks mentioned. The Motley Fool recommends Chevron. The Motley Fool owns shares of ExxonMobil. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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