Chevron-Exxon Texas Showdown Spells Trouble for Frackers

(Bloomberg Opinion) -- In case you missed it, Tuesday morning brought confirmation that it is officially on in Texas. Even as Mike Wirth, CEO of Chevron Corp., was wrapping up a session with analysts that could have been headlined “We rule in the Permian,” Exxon Mobil Corp. teased its own session coming on Wednesday with a press release that could have been headlined “Nah, we rule.”

The frack-off not only says a lot about where these two companies are, but also where all those other Permian players find themselves in early 2019.

Chevron projects that, at a $60-a-barrel oil price assumption, it will produce 900,000 barrels of oil equivalent a day in the Permian Basin in 2023, more than double its current level. Exxon, meanwhile, announced plans to increase its Permian production by almost 80 percent to more than 1 million barrels-equivalent by “as early as 2024.”

Apart from the spectacle of America’s two oil majors battling to be king of Texas, what’s striking about those targets is that they imply both companies will be relying on the Permian for roughly one of every four barrels they produce within the next five years. That is a most un-major-like level of concentration in one asset, especially one at home and not in some far-flung corner of the world. The supermajor rationale of get-together-and-go-forth, expounded in the megamergers of 20 years ago, isn’t dead exactly, but it’s no longer the guiding mantra.

The rationale was captured in Wirth’s comment that Chevron’s “risk is decreasing as our capital spending becomes more weighted towards smaller, shorter-cycle investments.” The vast majority of Chevron’s anticipated increase in production to 2023 will come from projects that are already sanctioned, and 60 percent of them will be in the Permian Basin. Roughly another 30 percent relates to other tight-oil reserves.

Wirth’s predecessor was dogged by years of big-ticket, delayed mega-projects that burned cash and hurt returns. In that way, Chevron exemplified a wider degradation in the majors’ reputation as stewards of capital. In addition, the specter of climate change and peak oil demand has, in effect, raised the risk premium on new long-term projects. Winning hearts and minds on Wall Street now involves keeping a tight rein on spending, having flexibility on drilling and production and paying out a bigger chunk of cash flow year in, year out.

For Chevron, shale — and Permian shale in particular —  is the key to that. The same goes for Exxon, even though it is playing catch up there, having had to buy its way into a big Permian position and lacking Chevron’s advantage in terms of low or no-royalty barrels.

Both companies claim relatively low costs to produce each Permian barrel and are investing to make their integrated model work, linking the basin with in-house pipelines, refineries and export facilities. They have yet to prove that this will work in terms of delivering cash returns. But it is fascinating to see both companies essentially go all-in on it — especially when shale’s pioneers, the smaller exploration and production companies, are struggling with their own model.

Having led the surge in U.S. oil production, the E&P sector is facing a reckoning as investors, activists among them, ask why a decade of success in output hasn’t translated into good returns on, and of, capital. It is telling that these stocks, leveraged to growth and oil prices, have lagged Chevron and the broader market since crude bottomed out in February 2016 (Exxon, not so much).

Chevron-Exxon Texas Showdown Spells Trouble for Frackers

As Roger Diwan of IHS Markit puts it: “The outperformance of the independents is completely gone.” Chevron isn’t promising 10 percent production growth overall, but it is guiding for growth of 3 to 4 percent a year on a bigger base and, crucially, dividends and buybacks. The next several years will show whether a major can make the Permian pay in that way. What is clear today is that investors casting a wary eye at promises of reform from E&P companies have another option for their money.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

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