Big oil giant Chevron Corporation (NYSE:CVX) is taking actions to maintain its profitability as a result of the dramatic drop in commodity prices. Among the actions it’s taking is to cut capital spending by 13% this year in order to conserve cash. One of the items it’s cutting from its budget is spending for the company’s proposed Kitamat LNG terminal in British Colombia, which is now the third proposed LNG project in Canada to be delayed over the past few months as Canada’s dreams of becoming a leader in LNG slowly begin to fade.
Pressing pause
Chevron’s decision to significantly slow spending on Kitimat isn’t really much of a surprise. The company’s former partner, Apache Corporation (NYSE:APA) recently bailed on the project having announced the sale its stake in Kitimat, as well as a Chevron-let project in Australia, to Australia’s Woodside Petroleum. So, with that transition taking place, not to mention the continued uncertainty in the oil market, it makes sense to slow down until things settle down.
It also doesn’t hurt that a rival project, the $36 billion Pacific Northwest LNG, has had its final investment decision delayed by Malaysia’s Petronas. Meanwhile, Britian’s BG Group has decided to hold off pursing its own Pacific coast LNG project until next decade. With these two rival projects not moving forward at this time there’s no need for Chevron to rush its project.
Not giving up
One thing that Chevron did make clear is that it is not giving up on its Kitimat project. The company is actually going to continue to develop natural gas fields in British Colombia that will be used to support the export facility. Further, it’s going to secure the permits and reach agreements with aboriginal groups so that it can move forward with the project once it has more clarity on the market.
In addition to that, the company is also going to continue do to the front-end engineering and design work with a focus on looking for ways to reduce the costs of the plant. One of the biggest issues the company has run into when it comes to LNG is cost overruns, which is what gave Apache pause and why it decided to exit the project. Chevron’s massive Gorgon project in Australia, for example, saw its costs balloon from the initial plan of US$37 billion to US $54 billion with worries that the final cost would rise by another 25% when all was said and done. When costs spike like that it makes it really hard to earn an economic return even at higher commodity prices.
The hope in delaying is that construction costs will come down so that the Kitimat, and other LNG projects in Canada, will be much more cost effective than previous projects have turned out to be. When the LNG boom initially started gaining steam a few years ago it caused tremendous cost inflation as, “everybody jumped into the pool at the same time, and we’re all trying to fight for the same floatable toys,” according comments made last year by Woodside Petroleum CEO Peter Coleman. Ideally, by delaying, Chevron will be able to engineer a project that can be economical under current conditions, instead of needing higher commodity prices to earn a decent return.
Investor takeaway
It wasn’t all that long ago that it was thought that Canada was about to emerge as a LNG powerhouse thanks to its abundant and cheap natural gas. However, the oil price plunge has put those dreams on hold as the economics of LNG are being impacted by both rising costs and falling commodity prices. The hope now is that costs will come down so that when these projects are built they’ll deliver strong economics and fuel a real economic boom in Western Canada.
