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Will a Reduction in Capex Help Improve Chevron’s Free Cash Flow?

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Oct. 27 2015, Updated 11:06 a.m. ET

Chevron’s free cash flow

Chevron’s free cash flow, or FCF, has mostly been negative in the past two years. FCF is equivalent to operating cash flows less capital expenditures, or capex. It’s an important metric as it denotes the leftover cash flows after deducting a company’s growth and maintenance expenses from the cash it generates from its regular operations. FCF enables a company to pursue opportunities that could enhance its shareholder value, such as dividend payments.

Chevron’s FCF was negative before the price of crude oil started falling. Its negative FCF levels started dipping even lower in 4Q14 after crude oil prices plunged further.

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The company has limited flexibility in its spending plans, and most of its spending is focused on huge long-term projects. Much of Chevron’s free cash flow deficit has been funded by long-term debt and asset sales. Even recently, the company resorted to debt issuances and asset divestitures to cover its YTD (year-to-date) dividend and capital expenditures. It added $4.9 billion in debt and sold off $4.1 billion in assets in the first two quarters of 2015.

Chevrons planned spending cuts

In its investor presentation released on September 9, Chevron (CVX) noted that it has identified more than $3 billion in spending reductions, which will be a combination of both capital and operating expenses. In the 2Q15 earnings call, Pat Yarrington, VP and CFO, had said that that these elements would show up at an accelerated rate in 3Q15 and 4Q15. She had also said that of the $3 billion, $1.4 billion would predominantly be reductions in operating expenses and $1.6 billion would predominantly be reductions in capital expenses.

A lower capex could help reduce the free cash flow deficit. However, in the current crude oil prices scenario, cash from operations is also likely to fall due to lower price realizations. Therefore, despite reductions in capex, the company might not see much improvement in its FCF. The company aims to improve free cash flow to cover its dividends by 2017.

CVX’s capex guidance for 2015 is $35 billion, compared to $40 billion in 2014. Its peer ExxonMobil (XOM) is slated to spend ~$37 billion in 2015, compared to $38.5 billion in 2014. XOM and CVX make up ~30% of the Energy Select sector SPDR ETF (XLE). Pure play upstream companies such as Occidental Petroleum (OXY) and ConocoPhillips (COP) made deeper cuts in their 2015 capex—33% compared to 2014.

CVX also makes up ~12% of the Vanguard Energy ETF (VDE).

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