Patricia Yarrington, the CFO at Chevron had a great quote during the last Chevron earnings call:
“But the value of the Permian and its tremendous economic capabilities and its capital efficiencies provide great flexibility because of its short-cycle, high-return attributes. Yes, other parts of the portfolio have to compete for capital against that. So I think it raises the bar on where that incremental dollar is going to go. Permian will get the first call but we will manage it as a portfolio, and over time you should still expect us to have some significant other projects but we can pace those projects quite nicely I think and match against the opportunities the Permian provides for us.”
The Permian Basin is one of the bright spots in Chevron’s asset base. The total development cost per barrel is only around $18, making this one of the all-weather spots where Chevron operates when the price of oil is low and the more expensive extraction efforts cease to make economic sense.
Chevron owns 2 million acres in the Permian basin across New Mexico and Texas, and Chevron estimates that 600,000 of these acres have a net value in excess of $50,000 per acre, and another 350,000 acres with a net value of at least $20,000. With the price of oil low, Chevron has ramped up Permian production almost 40% in the past three years. Chevron’s state goal is to get Permian production up to 300,000 barrels per day by the end of 2020.
You know what I like about Yarrington’s quote?
It creates a very competitive default option that is always consulted, increasing the likelihood of producing a superior outcome.
When you are a billion-dollar enterprise, it is very easy to look for something new for the sake of novelty. Why don’t we do this deepwater project? Why don’t’ buy that refinery? Shell has a presence in Nigeria, shouldn’t we? Based on their public disclosures, it doesn’t look like Chevron has that type of flawed center of gravity.
Warren Buffett has alluded to this at Berkshire shareholder meetings with the line “More of a good thing can be wonderful.”
Chevron has chosen a wise method of comparison by looking at the cash coming in and posing the question: “Is there anything we can do that’s better than putting more money in the Permian Basin? If not, that’s okay, ramping up production there has an instant 2x or 3x payoff.”
People might have bought Nike stock this summer at $55, and as cash becomes available to invest now, they disregard Nike at $49 because they feel that they have already done that. Unless you need diversification—you’re nearing retirement or have more than 20% of your net worth in an individual holding—you should compare uses of new capital against the prior investments that you still hold, especially if the price of any of them has gone down.
If someone considering an investment says “What can I find that offers better risk-adjusted returns than Nike?” as the default inquiry, you know they are going to make good decisions because they are only going to consider investments that have a double-digit return probability. They are avoiding the Peter Lynch trap of diworsifying or what Warren Buffett has called the Noah’s Ark approach to investing.
Chevron has maintained its dividend at $4.28 throughout the low oil price environment. They were also able to maintain their dividend during the late 1990s when oil was dirt cheap at $10 per barrel. With the exception of Exxon and Shell, this is unusual because the cash flows are so volatile. But one of the reasons why Chevron has maintained its dividend is because it is diligent in preserving free cash flows, and a constant comparison of new opportunities against the best pre-existing opportunity is one of the reasons why. This isn’t a plug for Chevron stock; it’s a lesson on improving human cognition by recognizing that enlarging a commitment to something pre-existing can be superior to prowling around for something new. Sometimes, buying Nike stock month after month is the most intelligent thing you can do.