In Chevron's Big Miss, Big Oil Looks Like Wildcat Explorer

NEW YORK (TheStreet) -- Chevron typically beats, but it's getting beaten up by investors for a change on earnings day.

Higher expenses on lower production always gets the independent exploration and production companies in trouble with investors, as do the surprise reasons for the discrepancy. Chevron seems to be getting a taste of that kind of market slap on the oil explorer wrist on Friday, with its production numbers down across the board in the fourth quarter as its expenses went higher.

Big Oil stocks don't tend to move much on earnings, but Chevron shares were down close to 3% on Friday, significant for a morning on which the energy sector was close to flat and crude oil higher. It's significant also that Chevron is the only major oil company to release an interim earnings report ahead of earnings day, which should limit the impact of the actual announcement on shares.

Higher expenses on lower earnings and production means a big earnings disaapointment for Chevron.

In that Chevron interim report released earlier this month, Chevron said refining would be weak and upstream -- exploration and production -- would be similar to the third quarter.

The refining weakness was obvious -- the business was at a loss in the fourth quarter. But that wouldn't have surprised anyone , and refining business isn't a big driver of earnings, though in recent quarters it has been an outperformer. Even moving to a loss, it wouldn't explain the size of Chevron's miss, and it was a big one: $2.58 in earnings from Chevron versus a consensus estimate of $2.85 from Wall Street analysts.

The E&P results were worse than expected. Chevron had said in the interim report that results would be similar to the third quarter, but the results were probably not what an investor would describe as similar.

Upstream earnings came in at $5.7 billion, versus $6.2 billion in the third quarter 2011. The sequential decline in E&P income was 10%. "More than I expected," said Argus Research analyst Phil Weiss.

"The fact that upstream earnings were as far off as they were could be behind the decline in shares ," said Raymond James analyst Stacy Hudson. Hudson noted that expenses for E&P went up, too, even as production declined. This could suggest that Chevron had some "dry holes" in the quarter that needed to be written off.

"The shares are off more than you typically see. Looks like a fairly big miss, especially when there was an update a few weeks ago to help frame expectations," said Weiss said.

Weiss said that production was expected to be slightly down, so the higher expenses are the likely driver of the upstream miss. "I'm never a fan of rising expenses. If that carries forward, it's even a bit more disconcerting," Weiss added.

The Argus analyst said exploration expenses do move around, but are also typically higher in the fourth quarter, and still the Chevron number was higher than what he modeled.

Chevron reported E&P expenses of $388 million in the quarter. Expenses move around quarter to quarter -- in the first quarter of 2011 the same line item was $168 million but moved up to $422 million in the second quarter. Nevertheless, "It was higher than we expected," Hudson said.

Weiss said the bigger expense line that stood out was operating expenses of just under $7.3 billion, up from $6.4 billion in the third quarter.

Charges went up from $358 million in $553 million in the fourth quarter. The company said during the conference call with analysts that it had some significant tax charges that would not be re-occurring. CEO John Watson said nothing had substantially changed about the company's portfolio and it will continue to perform well with high oil prices and in addition, some of Chevron's newer portfolio additions merit more recognition.

This could just be one more opportunity to buy into a major after a dip -- ConocoPhillips declined into earnings on the release of its report earlier this week, leading analysts to say it was a chance to buy -- but in the case of Chevron, it's the type of disappointment that the market hasn't been accustomed to, and a big one, and the market is reacting to it as a result. Hudson said it's still a strong buy, but she has some questions for management about the expense increase and impact on earnings. Big Oil stocks ran up to 52-week highs late in 2011 and that carried over to the beginning of this year. High oil prices and the 2011 investor craze for the safety of dividends amid the macroeconomic jitters helped Big Oil stocks, but could also suggest near-term upside is limited.

The typical reason for a decline in Big Oil shares is simply profit-taking, or a bad day for the energy tape and crude oil on earnings day, or a production growth shortfall being used as a reason to sell.

Worldwide net oil-equivalent production was 2.64 million barrels per day in the fourth quarter 2011, down from 2.79 million barrels per day in the 2010 fourth quarter. In the U.S., production of 661,000 barrels per day in the fourth quarter 2011 was down 37,000 barrels per day, or 5%, from a year earlier. In international, production of 1.98 million barrels per day in the fourth quarter 2011 was down 108,000 barrels per day from a year ago. The decline in liquids production of 7% in both the U.S. and international was much higher than the 1% to 2% decline in natural gas production. On top of production going down, it's not good to have the decline led by oil with natural gas trading a historically low prices in the U.S.

Chevron did put up the weaker production numbers year over year, though sequentially total production was up from 2.6 million barrels in the third quarter 2011. The company fell short in the full year 2011 of its goal of increasing production by 1% annually and sees 2012 production flat year over year. But that wasn't the focal point on Friday, because for a change with Big Oil there were other short-term concerns trumping the longer-term picture.

News flow has not been good of late for Chevron. A natural gas fire in Nigeria still burns today, and Chevron also got some more bad news from Brazil late on Thursday when a federal prosecutor already suing the company for $11 billion for its Frade field oil spill said he planned to send Chevron executives to prison. These events added to the long-running case in Ecuador in which a recent court judgment against the oil company was set at $17 billion, though Chevron is not giving up that battle.

Responding to the post-Macondo world, Chevron CEO Watson put it simply, saying, "We need to not put oil in the water." He added that expectations were higher than they were even two or three years ago, and in the end the rule of law should prevail, but a company in its position working overseas in countries with national oil companies has to expect there to be interests that will come down hard on any environmental incidents.

It could just be posturing from Brazil about sending Chevron executives to jail, but the news flow continued to be bad for Chevron on Friday, and it's the market penalty box that mattered to Chevron on earnings day.

-- Written by Eric Rosenbaum from New York.

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