Two is better than one, or the combination of two would make for a bigger company in Chevron’s case. It has recently been announced that Chevron is purchasing Hess for US$53 billion. Both are oil & and gas companies in the global economy, with extraction facilities worldwide.

In this article, we will explore the following details regarding this transaction:

1. Why is Chevron acquiring Hess
2. What are the implications to the markets of crude oil and natural gas
3. How does this impact you in your investment and daily life

Hess’s Project in Guyana is the Main Focus for Chevron

Let’s get straight to the point. Hess’s main project in collaboration with Exxon in Guyana is expected to produce up to 1.2 million barrels per day (bpd) by 2027. Chevron obtained a 30% stake in the joint venture by acquiring Hess, potentially boosting its total oil output to 3.7 million bpd.

Here are the key details of the project:

1. ExxonMobil is the operator of the project
2. Total estimated reserves of 11 billion barrels of oil (Estimated US$909 billion worth of oil based on Brent crude oil price of US$82.64. This is equivalent to 3.7 times Chevron’s 2022 revenue of US$246 billion)
3. Oil breakeven price of US$25-US$35 per barrel, making margins very lucrative for the project.

Chevron has been on an acquiring spree in recent years, buying up PDC Energy and Noble Energy to increase its production of shale gas. Hess in this regard suits the profile and strategy of Chevron, as Hess has significant shale gas assets also.

But the big question is will the acquisition help Chevron in terms of operational efficiency,

There are Some Operational Efficiencies to be Achieved but Not Much

Essentially, two financial margins are important to consider in an acquisition. The net profit margin (net income/revenue) and return on asset (net income/total asset).

By right, Chevron is looking for improvements in both these margins when acquiring Hess, but the story is mixed. The net profit margin for Hess is indeed higher at 17.6% in 2022 compared to Chevron’s 15.0%. However, 2022 can be considered an abnormal year since the war in Russia and Ukraine caused oil prices to soar. This meant that most oil & and gas companies had a bonanza year.

Hence, the year 2021 might be more suitable. On this front, the net profit margin is at 7.2% now much lower when compared to Chevron’s 10.0%. Furthermore, even accounting for return on asset in 2022, Hess’s return on asset (9.7%) was also lower compared to Chevron’s (13.8%).

RBC analysts have opined that there is a potential US$1 billion in cost synergies for the acquisition but I think most of that cost synergies would just come from the lower cost of oil from the Guyana project. There isn’t any operational efficiency from an overall company standpoint to be gained by Chevron at this stage.

Chevron is Cash-Rich so that it Can Afford Hess

What do you do when you have piles of cash around? You put them in the bank to get a fixed deposit rate or you go out on a shopping spree. Chevron chose the latter.

As of the end of 2022, Chevron had a massive cash pile of US$18 billion compared to only US$6 billion in 2021. That cash pile has since declined to US$10 billion (June 2023) as Chevron embarked on purchasing PDC Energy and Noble Energy.

However, that US$53 billion seems too big of a purchase for its current cash position. Chevron did say it plans to sell about US$15 billion to US$20 billion of assets, and the rest could be covered by taking on more debt. It is worth noting also that it has a total accounts receivable of US$19 billion.

What are the Implications for Oil Markets?

To answer this question, we need to look at the effect of consolidation (in this case, the acquisition of competitors by a bigger company) on the cost and supply of crude oil. It typically means two things:

1. Consolidation normally reduces the cost of production per barrel of oil. Economies of scale will help bigger companies do this, by negotiating for a lower cost per unit since they buy raw materials and equipment in bigger bulks.
2. The combination of companies could in theory increase production and supply to the market as the cost of production decreases. Hence, the combined company produces more.

Chevron’s acquisition and increased production could theoretically increase supply to the market and reduce oil prices. More supply = lower prices and more quantity supplied.

However, this has several flaws. We are assuming that production increases with Chevron buying up more companies and that Chevron will be able to reduce the cost of production per unit. The analysis before this showed that this might be unlikely considering that Hess’s operational efficiency is lower than Chevron’s.

Hence, I think oil prices will probably not decline by that much even with this acquisition. However, if we are talking about the companies and oil & and gas sector share prices, that is another matter.

How does this affect your investments and daily life?

In any mergers & acquisitions deal, share prices for both companies normally go up if they are perceived positively by the market and vice versa. Based on the recent share price performances since 23 October 2023, seems like the deal is bad for both Chevron (-9.0%) and Hess (-11.9%).

If you have invested in both companies, it might be a good idea to evaluate this deal again to see whether your investment value will increase in the long term. However, in the short term, it seems like the deal is looked on as still negative by investors. It could be that investors are taking profits off now from the oil & gas sector considering that oil prices are low and the world heads to a potential recession.

In terms of daily life, this deal could theoretically increase supply to the oil market and reduce prices. This is considered positive for countries that import a lot of crude oil for consumption. For Malaysia, this is good because the government would spend less on subsidies. However, on another front, if you are working in a country that relies on the oil & gas industry, lower prices might mean lower profits for the company and indirectly, potentially lower salaries for you.