How Will Chevron (CVX) Stock Be Impacted By Oil Production Cut?

Elevator Pitch

I am raising my investment rating for Chevron Corporation’s (NYSE:CVX) stock from a Hold to a Buy.

I determined that the potential upside for CVX wasn’t sufficiently appealing at the point of time that I wrote my prior article for Chevron Corporation on June 9, 2022. But things have changed quite a fair bit in the past couple of months. Chevron Corporation’s shares have pulled back by almost 10% since my previous update; and there is the recent news of a cut in oil production which is the focus of my latest article.

My analysis leads me to the conclusion that the oil production cut should drive oil prices up, which will be positive for Chevron Corporation. As such, I choose to rate CVX as a Buy now, as compared to a Hold previously.

Why Is Oil Production Being Cut?

“OPEC+ has decided to reduce production by 2M bbl/day” beginning in November, as highlighted in an October 5, 2022 Seeking Alpha News article. One has to refer to the official statement issued by OPEC or Organization of the Petroleum Exporting Countries to understand the reason for the oil production cut.

In the OPEC press release issued on October 5, it was highlighted that this move was aligned with “the successful approach of being proactive, and pre-emptive.” More importantly, the media release noted “the need to enhance the long-term guidance for the oil market” in view of “uncertainty.”

In other words, OPEC+ is concerned that there will be a substantial undersupply of oil in the long run, which makes it important that oil prices remain sufficiently high to motivate energy companies to invest in exploration and production activities. The weak economic environment threatens to depress demand for oil, and drag oil prices down in the near term. To make sure that the bear-case scenario for oil prices doesn’t pan out, OPEC+ has decided to act swiftly to leverage on oil production cuts as a means of stabilizing oil prices.

What Will Happen When OPEC Reduces The Production Of Oil?

The effects of a reduction in the production of oil are fairly straightforward. The supply-demand dynamics for oil will become more favorable, and oil prices are expected to remain elevated in the foreseeable future. This is reflected in the updated sell-side analysts’ forecasts as detailed below.

Based on an October 5, 2022 research report (not publicly available) titled “Tighter Balances after OPEC Cut” published by Morgan Stanley (MS), the MS analysts estimate that actual oil production will decline by 0.8 mb/d (millions of barrels per day) which will “see the oil market nearly 1 mb/d undersupplied once again in 2023.” Analysts from Barclays (BCS) are of the view that there will be a 0.9 mb/d decrease in oil output following OPEC+’s decision, as per a October 6, 2022 BCS report (not publicly available) titled “Taking Charge”.

BCS predicts that the price of Brent will rise to $103 in 2023; while MS forecasts that the Brent price should go up to $100 in the first quarter of next year and hit the $110 mark by the final quarter of 2023.

How Will Chevron Be Impacted By The Cut?

The cut in oil production will have a positive impact on Chevron Corporation. CVX’s share price performance in the past one week sends a clear signal that the oil production cut is a favorable development for the company.

Chevron Corporation’s stock price surged by +6% from $143.67 as of Friday, September 30, 2022 to $151.73 at the end of the Monday, October 3, 2022 trading day, after news broke on October 3 that OPEC+ was contemplating an oil production cut. It is noteworthy that CVX’s shares continued to rise in the subsequent trading day, and closed even higher at $160.03 as of October 7, 2022.

Elevated oil prices are largely good for Chevron Corporation because of the company’s revenue mix. In the first half of 2022, CVX derived 80% of its earnings from the upstream segment (as opposed to the downstream segment), as revealed in its Q2 2022 10-Q filing.

More importantly, Chevron is recognized as a key proxy for rising oil prices by the investment community, and this implies that CVX’s actual share price performance will be significantly correlated with oil price movements.

Piper Sandler noted in a May 9, 2022 report (not publicly available) titled “Steady As She Goes” that “CVX is the most oil-levered of its peers.” Another June 6, 2022 energy sector report (not publicly available) titled “More Room To Run” issued by Morgan Stanley highlighted that Chevron Corporation has “higher leverage to oil prices” in comparison with key peer, Exxon Mobil (XOM).

CVX Stock Key Metrics

Chevron Corporation’s key metrics which warrant attention from investors relate to the stock’s shareholder capital return.

CVX offers a potential total shareholder return yield of approximately 7.2% based on my calculations, which is very attractive. This is derived based on Chevron Corporation’s consensus forward next twelve months’ dividend yield of 3.6% (source: S&P Capital IQ), and the company’s guidance of allocating as much as $15 billion to share repurchases this year (equivalent to a buyback yield of 3.6%).

Assuming oil prices rise to a greater extent than expected due to the oil production cut, this might translate into higher free cash flow and more excess capital available for shareholder capital return. This suggests that Chevron Corporation’s actual share buybacks and dividends in the future could even be better than what investors are anticipating.

What Is The Long-Term Prediction For CVX Stock?

Predicting how CVX will perform in the long run is the same as forecasting the pace of energy transition.

My prediction is that Chevron Corporation’s business and shares will perform well in the long term, as I take the view that energy transition will happen at a much slower pace than what most people expect. Recent geopolitical events such as Russia’s invasion of Ukraine have brought energy security back into the spotlight, and this makes it more likely that governments around the world will place a relatively greater priority on conventional energy as opposed to renewables.

Is CVX Stock A Buy, Sell, Or Hold?

CVX stock is a Buy. The cut in oil production will be supportive of oil prices in the short term, and this suggests that shares of Chevron Corporation, an oil price proxy stock, should trade higher.