Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Here are two observations about the rumored departure of John Watson as CEO of Chevron Corp.:

  • Provided he stays out of politics, he should have an easier life than Rex Tillerson, who left Exxon Mobil Corp. for the somewhat less well-oiled machine known as President Trump's administration;
  • His successor should have an easier life than Darren Woods, the man who filled Tillerson's shoes.

Watson, who took over running Chevron in January 2010, is said to be considering stepping down, as first reported Tuesday in The Wall Street Journal (a spokesperson said the company doesn't comment on speculation).

Assuming he is heading off, Watson's tenure will have been defined by three things: the struggle to deliver on Chevron's backed-up queue of projects; the struggle to deal with the collapse in oil prices; and the recent pivot towards the Permian shale basin.

You no doubt noticed the word "struggle" appeared more than once there. Chevron's need to finish mega-projects like the $54 billion Gorgon LNG facility in Australia coincided unfortunately with the oil crash. As with its peers, this demonstrated the extent to which Chevron had trashed its return on capital in pursuit of growth and sent free cash flow deeply negative:

Big Spender
Chevron's heavy spending meant its free cash flow was already in the red in 2013. The oil crash delivered the coup de grace
Source: Bloomberg

Watson came into the oil crash expecting it to reverse quite quickly. Only a few months before, he was quoted as saying that $100 oil was "becoming the new $20."

To his credit -- and fortunately for Chevron's shareholders -- Watson seeems to have abandoned this view. Speaking at the company's analyst day in March, he acknowledged the dampening effect of efficiency gains across the industry and stated categorically that "we're not going back to $100 oil anytime soon."

This has pushed Chevron to change course significantly. These days, it focuses on reducing its breakeven oil price, or the price at which it can cover capital expenditure and its dividend from operating cash flow. As you can see in the chart above, Chevron pretty much did that in the second quarter when Brent crude averaged about $50 a barrel.

All the oil majors are doing this, of course. Where Chevron is different is that, at least through the rest of the decade, it should clock up production growth of around 5 percent a year. In large part, this is just a function of cresting the hill: Having struggled to bring its giant projects onstream, it now gets to enjoy rising production and lower spending, portending an increase in both free cash flow and go-forward return on capital (fully discounted project return on capital is another matter.) This also reflects the company's strong Permian shale position, a flexible source of production growth and a clear pillar of valuation support.

From investors' perspective, Chevron has come through the worst of its trials and looks like a pretty solid investment relative to other oil majors, especially Exxon. That's a favorable legacy for Watson to leave to his successor. 

Like Woods at Exxon, whomever replaces Watson will have to prove that Chevron's pivot to U.S. shale really can provide solid returns despite the business's capital intensity. While Chevron doesn't have Exxon's unenviable track record of 10 straight quarterly net losses in its U.S. upstream business, there's been a lot of red ink spilled there over the past few years. Chevron's exposure to Venezuela -- which accounts for about 3 percent of its production -- is also a concern.

Still, Exxon's lack of growth and doubts about its long-term project pipeline due to Russian sanctions make it tough to come up with a compelling buy case beyond the traditional defensive one -- and even that has been dented in the past year or so. This has allowed Chevron's relative valuation to catch up; indeed, on price-to-book multiples, the gap is close to the narrowest it's ever been during Watson's tenure:

Going Out On A High?
Amid reports that Watson will step down as CEO of Chevron, the company's valuation gap versus its arch-rival is the narrowest of his tenure
Source: Bloomberg

All in all, then, Watson's successor would be assuming control at a relatively good time (there's still that whole peak-oil-demand worry to contend with).

One last point: the prime candidate to be the next CEO is current vice-chairman Michael Wirth. If he took over, Chevron would join Exxon and Royal Dutch Shell Plc in having placed a man from the downstream part of the business in the top job.

This may be mere coincidence. Yet with the energy industry as a whole suddenly touting the strengths of downstream businesses such as refining, chemicals and even marketing these days it's hard to shake the idea that there's more to it. 

The tough, volatile downstream business has always been about minimizing spending and sweating assets relentlessly -- exactly the sort of skill set required in today's oil market.

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

To contact the author of this story:
Liam Denning in New York at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net