- Chevron shares have rallied on surging oil prices
- Price is above the consensus 12-month price target
- But oil price has fallen 18% over the past several weeks
- Options market indicates a slightly bearish view to early 2023
After closing at $130.50 per barrel on Mar. 7, oil prices have slumped. Even so, at the current price of $107.10, oil is 74% higher than at the start of April of 2021. Oil prices have risen on the back of a recovery in global demand and Russia’s invasion of Ukraine.
Chevron (NYSE:CVX) shares have surged, along with those of many other energy companies. CVX has returned a total of 40.5% over the past three months and 58.8% over the past 12 months. The share price has stabilized in the past several weeks.
Source: Investing.com
Rising inflation and interest rates tend to be positive for oil company earnings. With inflation near forty-year highs, the global energy giant should continue to see strong earnings growth. The wild card, however, is how much of the current oil price high is due to concerns about the Russia-Ukraine situation. That might be assuaged if peace negotiations make progress. The consensus outlook for earnings growth is 7.3% per year over the next three to five years.
I last wrote about CVX on Sept. 20, 2021, just over six months ago; I assigned a buy rating and since then, CVX has returned a total (including dividends) of 72.9%, as compared with 2.2% for the S&P 500. The outlook for the oil giant depends on expectations for future demand, oil prices and the potential for regulatory changes.
In forming my opinion on CVX, I relied on two forms of consensus outlooks. The first is the well-known Wall Street analyst consensus. The second is the market-implied outlook, the implicit consensus view among buyers and sellers of options on CVX that is calculated from options prices. In September, the Wall Street consensus rating on CVX was bullish and the consensus 12-month price target was about 28% above the share price at that time. Even given CVX’s fairly high volatility, the Wall Street consensus indicated an attractive risk-return proposition. The market-implied outlook was slightly bullish into early 2022 and predominantly neutral for the period to mid-March.
For those who are unfamiliar with the market-implied outlook, a brief explanation will suffice for the purposes of this discussion. The price of an option reflects the market’s consensus estimate of the probability that the share price will rise above (call option) or fall below (put option) a specific level (the option strike price) between now and when the option expires. By analyzing the prices of call and put options at a range of strikes, all with the same expiration date, it is possible to calculate a probabilistic price forecast that reconciles the options prices. This is the market-implied outlook. For those readers who want a deeper dive than provided in the previous link, I recommend this outstanding (free) monograph from the CFA Institute.
More than six months have passed since my last analysis of CVX and Russia’s ongoing invasion of Ukraine has generated considerable turmoil in energy markets. I have updated the market-implied outlook for CVX through the end of 2022 and compared this with the current Wall Street consensus outlook.
Wall Street Consensus Outlook For CVX
E-Trade calculates the Wall Street consensus outlook for CVX by combining the views of 22 ranked analysts who have published ratings and 12-month targets over the past 90 days. The consensus must be considered in light of the fact that the invasion started on Feb. 24, about five weeks ago. The consensus rating is bullish but the consensus 12-month price target for CVX is 1.95% below the current share price.
Source: E-Trade
Investing.com’s version of the Wall Street consensus is calculated using the views of 29 analysts. The consensus rating is bullish and, similar to E-Trade, the consensus 12-month price target is slightly below the current share price.
Source: Investing.com
In September, the consensus 12-month price target was around $124, as compared with about $162 today. Even though the share price target has increased substantially, the share price has gone up faster.
Market-Implied Outlook For CVX
I have calculated the market-implied outlook for CVX for the 2.6-month period from now until June 17, 2022, and for the 9.7-month period from now until Jan. 20, 2023, using the prices of call and put options that expire on these dates.
The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and return on the horizontal.
Source: Author’s calculations using options quotes from E-Trade
While the market-implied outlook for the next 2.6 months is generally symmetric, the peak probabilities are shifted to favor negative price returns for this period. The maximum-probability outcome corresponds to a price return of -2.3%. The expected volatility calculated from this distribution is 30.4% (annualized). For context, the expected volatility calculated in September was 29%.
To make it easier to directly compare the probabilities of positive and negative returns, I rotate the negative return side of the distribution about the vertical axis (see chart below).
Source: Author’s calculations using options quotes from E-Trade
This view shows that the probabilities of negative return are consistently higher than for positive returns over a wide range of the most-probable outcomes (the dashed red line is above the solid blue line over the left two-thirds of the chart above). The elevated probabilities of negative returns indicates a slightly bearish view from the options market.
Theory suggests that the market-implied outlook will tend to have a negative bias because investors, in aggregate, are risk averse and tend to pay more than fair value for downside protection. There is no way to determine whether such a bias is present, however. Considering the potential for this bias, I interpret the market-implied outlook for CVX to be neutral to slightly bearish.
The market-implied outlook for the next 9.7 months, from now until Jan. 20, 2023, exhibits a slightly stronger bearish tilt. The maximum probability corresponds to a price return of -4.5% and the expected volatility is 31.4% (annualized). I interpret this outlook as slightly bearish.
Source: Author’s calculations using options quotes from E-Trade
The market-implied outlooks for CVX to the middle of 2022 and into early 2023 are slightly bearish, more so for the longer period. The expected volatility is quite stable, increasing slightly over time.
Summary
After underperforming for years, oil companies have enjoyed huge gains over the past 12 months. The rally results from broadly increasing inflation and, more recently, due to worries about the effect of the Russia-Ukraine conflict.
After gaining 58.8% over the past 12 months, what comes next for Chevron?
The Wall Street consensus outlook has a bullish rating, but the consensus 12-month price target is slightly below the current price. The market-implied outlooks for the middle of 2022 and to early 2023 are slightly bearish. The expected volatility calculated from the market-implied outlook is slightly higher than in September of 2021, but still reasonable. The options market is not pricing in much potential for a major decline in CVX.
So with CVX trading above the 12-month consensus price target, even with a major increase in the consensus price target over the past six months, along with the slightly bearish market-implied outlooks, I am changing my rating from bullish to neutral. Even considering the inflationary environment and the potential for price shocks due to the Russia-Ukraine conflict, Chevron shares have limited additional upside.