Key Points
Chevron has agreed to a new midstream services deal with Hess Midstream.
It's exchanging its ownership in Hess Midstream and its DJ Basin midstream assets for future cost savings.
The win-win deal will benefit both companies over the long run.
Chevron (NYSE:CVX) is unloading some of its midstream assets, including its stake in Hess Midstream (NYSE:HESM). The deal will simplify its operations and balance sheet, while saving it money over the long term. However, it comes with an upfront hit of a $3 billion-$4 billion one-time after-tax loss.
Here's a look at what this transaction means for an investment in Chevron.
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Drilling down into the deal
Chevron has agreed to divest its ownership interest in Hess Midstream and its DJ Basin crude oil midstream assets in exchange for extended and improved midstream commercial terms. The oil giant will contribute all of its existing ownership interests in Hess Midstream (acquired as part of its Hess purchase), which includes over 77.8 million Class B units, 449,000 Class A units, and 100% of its general partner interest. Hess Midstream will cancel those Class A and Class B units, reducing its outstanding shares by nearly 40%.
In addition, Chevron will transfer its DJ Basin crude oil midstream assets to Hess Midstream, which it acquired when it bought Noble Energy and subsequently purchased Noble Midstream Partners. These assets include 400,000 barrels per day of oil-gathering capacity, 300 million cubic feet per day of gas-gathering capacity, and 420,000 barrels of storage capacity. Hess Midstream will also receive a 20% interest in the Saddlehorn long-haul crude oil pipeline.
In exchange, Hess Midstream has agreed to reduce the tariff rates for providing Chevron oil and gas gathering and processing services in the Bakken from 2027 through 2033. The companies also agreed to extend the agreement through 2045, which aligns with the extended terms of the DJ Basin agreements. Chevron will also receive $200 million in cash as part of the deal.
How these agreements will benefit Chevron
The revised contracts will reduce Chevron's Bakken unit midstream costs by about 50%. That will enhance its future earnings and return on capital employed (0.5% accretive). This lower rate will support Chevron's future investment in the Bakken, with the company expected to run a two-rig drilling program from 2027 through 2029.
While these future cost savings are valuable to Chevron, it can't recognize them as an asset. As a result, it expects to record a one-time, after-tax loss of between $3 billion and $4 billion. It's transferring valuable midstream assets to Hess Midstream in exchange for future cost savings. Chevron will also deconsolidate Hess Midstream from its balance sheet after the deal closes, removing around $3.7 billion of its debt.
The agreements accomplish several things for Chevron. It simplifies its portfolio and balance sheet, and locks in significant long-term cost savings. That should enable it to generate more free cash flow from its Bakken assets in the future.
How these agreements benefit Hess Midstream
Hess Midstream will become a fully independent entity once the deal closes. The pipeline company will also become a multi-basin midstream company by adding the DJ Basin to its operations. As a result, it will diversify the company's operations and customer base by increasing third-party revenue. The separation will also enable Hess Midstream to pursue additional acquisitions to further diversify and grow its operations.
While the deal will reduce its earnings and cash flow in the near term, it's accretive on a per-share basis after accounting for the 40% decline in its share count. That will enable the company to maintain its current dividend level next year, which it plans to hold flat until its free cash flow grows to the point where it can fully fund its payment.
A win-win deal
Chevron is simplifying its portfolio and balance sheet while also receiving meaningful long-term midstream cost savings in exchange for its ownership interest in Hess Midstream and its DJ Basin midstream assets. Meanwhile, Hess Midstream gains its independence and increased diversification in exchange for a near-term reduction in income. It's a win-win deal that should enhance shareholder value for both companies over the long term.
Matt DiLallo has positions in Chevron. The Motley Fool has positions in and recommends Chevron. The Motley Fool has a disclosure policy.