Chevron Seizes an Opportunity in South Africa

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Following in the footsteps of Royal Dutch Shell (NYSE: RDS-A), Chevron (NYSE: CVX) has now started hunting for shale gas in South Africa. According to the U.S Energy Information Administration, the country has 485 trillion cubic feet of recoverable shale gas resources, roughly half the size of U.S’s reserves of 862 trillion cubic feet. South Africa is looking to create thousands of more jobs from foreign investment in its energy sector while it needs cheap natural gas to fuel its massive mining operations. Chevron will be partnering with the Canada based Falcon Oil and Gas to hunt for the unconventional fuel in South Africa.

However, the operation is bound to invite the ire of environmental groups. South Africa had placed a ban on the exploration of shale gas a year ago due to concerns related to the drilling technique used to extract shale gas called ‘fracking.’ The procedure requires the use of enormous quantities of fresh water, a resource already scarce throughout the world and more so in Africa, which is pumped into the shale rocks at high pressure causing the rocks to fracture. Nonetheless, the ban was lifted temporarily just three months ago and Chevron used this opportunity to announce its South African plans.

The country’s equity market is represented in the iShares MSCI South Africa ETF (NYSEMKT: EZA). Its economy has been hit by massive mining strikes, the likes of which were seen only in the days of apartheid. The country’s GDP is slowing down quickly. Analysts’ data compiled by Bloomberg were expecting its GDP growth for the third quarter to drop to 1.5%; it slid by 1.2%. The strikes alone have cut the growth rate by 0.5 percentage points. The country’s unemployment rate has remained above 20% since 1997 but the most recent data for the third quarter of 2012 has revealed that it has now climbed to more than 25%. 

Amid the economic downturn, South Africa has to pay billions in energy import bills as the country’s local capacity can only fulfill 40% of its energy needs. A study conducted by the think-tank Econometrix suggested that South Africa could solve its lack of fuel and unemployment problems by tapping into its shale gas reserves, but since the study was conducted on the back of Shell’s investment, its result were largely discarded by environmentalists in a classic example of the genetic fallacy of logic. Nonetheless, there is no doubt that shale gas could transform the energy landscape of South Africa like it has already done in the U.S.

Chevron’s last quarterly results were particularly disappointing for its investors as output fell to its lowest level in four years. Coupled with falling oil prices and a 65% drop in refining profits, Chevron posted net income of $5.25 billion, which is ~33% less year over year. This news was followed by another disappointment for Chevron’s investors in which the company reported that it was increasing the cost of its Australian massive LNG project at Gorgon by $9 billion to $52 billion while actual production has been delayed by about three months to the first quarter of 2015. With 47.33% ownership in the project, Chevron is the biggest stakeholder in Gorgon which is turning out to be less and less attractive with each passing year.

<table> <tbody> <tr> <td> <p><strong> </strong></p> </td> <td> <p><strong>Chevron</strong></p> </td> <td> <p><strong>Shell</strong></p> </td> </tr> <tr> <td> <p><strong>Stock 2012</strong></p> </td> <td> <p>+1.64%</p> </td> <td> <p>-5.66%</p> </td> </tr> <tr> <td> <p><strong>P/E</strong></p> </td> <td> <p>9.02</p> </td> <td> <p>8.17</p> </td> </tr> <tr> <td> <p><strong>EPS</strong></p> </td> <td> <p>12.19</p> </td> <td> <p>8.44</p> </td> </tr> <tr> <td> <p><strong>Yield</strong></p> </td> <td> <p>3.30%</p> </td> <td> <p>4.70%</p> </td> </tr> <tr> <td> <p><strong>Payout Ratio</strong></p> </td> <td> <p>28.00%</p> </td> <td> <p>34.00%</p> </td> </tr> <tr> <td> <p><strong>ROA</strong></p> </td> <td> <p>10.25%</p> </td> <td> <p>6.90%</p> </td> </tr> <tr> <td> <p><strong>ROE</strong></p> </td> <td> <p>18.91%</p> </td> <td> <p>15.15%</p> </td> </tr> </tbody> </table>

It will take several years for Chevron to produce any actual output from its South African projects.  So, investors looking for immediate returns will be disappointed.  But for both Chevron and South Africa, tapping into its shale gas reserves is necessary as the cost of imported energy will only increase as global demand and monetary pressures force both the real (priced in gold) and nominal price of energy higher.  EZA has risen by 17.21% in the same period it has witnessed a net outflow of $40.36 million in 2012. The ETF allocates 19.45% to‘basic materials’ while ‘financials’ form the dominant area with 23% weight. EZA is not heavily exposed to South Africa’s mining sector. 

PeterPham8 has no position in any stocks mentioned. The Motley Fool recommends Chevron. 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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