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Online Extra: ChevronTexaco's "Oily" Problem


By Christopher Palmeri Technology gurus had been preaching about first-mover advantages for years, but it took a while for the idea to catch on in the oil patch. BP's (BP) trend-setting chairman, John Browne, put the concept into practice when he announced the first major oil merger in more than a decade with his 1998 acquisition of Amoco. Exxon (XOM) followed four months later when it made a deal with Mobil. That left Chevron (CVX) with just one major partner, Texaco, and it has turned out to be the weakest of the three, analysts say.

Although BP's and Exxon's mergers were widely considered successes, ChevronTexaco stumbled at the start. A year after its 2001 combination, the new outfit had to take major write-downs on Texaco oil fields. ChevronTexaco Chairman and CEO David O'Reilly a former competitive runner, stuck it out, however. His judgment appears to have been on target because lately ChevronTexaco's earnings have been hitting their stride.

FLAT PRODUCTION. Buoyed by surprisingly strong commodity prices and merger-related cost-cutting that saved $2.2 billion a year, ChevronTexaco's earnings jumped 556% last year, to $7.4 billion, on $112 billion in sales. At a recent price of $88 per share, its stock has leaped more than 40% from its pre-Iraq War low. And O'Reilly has won ChevronTexaco a spot at No. 14 in BusinessWeek's 50 latest list of the top-performing U.S. companies.

Still, the good times may not last. Oil prices have benefited from the best of all worlds lately: rising demand from rapidly developing China (and from gas-guzzling SUVs), production problems in Iraq and Venezuela, and newfound cohesion among OPEC members that's curtailing supply. Even in ChevronTexaco's California backyard, tight gasoline supplies are creating fat profits at the pump. However, many analysts expect commodity prices to trend down by yearend if heightened tension in the Middle East eases.

However, if crude prices remain high, O'Reilly has his work cut out for him, despite the admirable progress already made. ChevronTexaco's U.S. fields are declining faster than he can replace production internationally. As a result, the company's worldwide oil and gas production is expected to stay flat at around 2.6 million barrels per day in 2004. It has major new fields coming on line in West Africa, the Gulf of Mexico, and Kazakhstan. But production there won't begin to kick in until sometime in 2006 or 2007.

EARNINGS SLIDE? ChevronTexaco is targeting big new natural gas fields in Australia and West Africa. Liquefying the gas and shipping it in tankers to the U.S. could help solve the country's current natural gas crunch. But, again, those developments are years in the future, and until then ChevronTexaco remains among the most "oily" of the major energy companies, meaning its earnings are among the most tied to fluctuations in the price of crude.

According to Reuters Research, analysts expect ChevronTexaco's earnings to slide from nearly $7 per share last year to $6.10 this year -- and $5.42 in 2005. Four of the 21 analysts who follow ChevronTexaco, according to Reuters, rate it a sell or an underperform. Six rate it a buy or outperform. Jack N. Aydin, an energy analyst at McDonald Investments, who rates it a hold, says "we believe the easy money has been made in the stock."

ChevronTexaco is looking a lot better than it did in the year after its big merger, but the near-term threats of declining oil prices and weak production growth could hurt. As the technology gurus warned for years, once you lose the first-mover advantage, it can be painstaking to catch up. Palmeri is a correspondent in BusinessWeek's Los Angeles bureau

EDITED BY Beth Belton


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