Oil companies are reporting their best earnings since the downturn in oil price began in mid-2014. Global crude oil inventories are coming down. It looks almost certain that when OPEC meets this month, it will agree to extend the product cuts enacted last November. 

Thus, it only makes sense that — the energy sector is tanking?

I must admit it’s a frustrating time to invest based on company fundamentals. Just look at a company like Tesla (NASDAQ: TSLA) that is bleeding cash as far as the eye can see. The government still provides generous subsidies that help Tesla and other makers of electric vehicles (EVs) sell cars, and yet Tesla still regularly loses money. But that hasn’t kept the share price from rising to the point that it recently sported a market capitalization greater than Ford (NYSE: F) or General Motors (NYSE: GM). That’s an insane valuation that will eventually come crashing down, but until then investors have lost a tremendous amount of money betting against it (and, perhaps more importantly, against Elon Musk). That’s because investors can ignore fundamentals for a long time.  

Which brings me to an opposite scenario, highlighted by the recent quarterly results posted by portfolio holding Chevron (NYSE: CVX). I covered the highlights already in the last Energy Letter, Big Oil Posts Big Profits. As the headline indicates, it was a great quarter across the board for Big Oil, with all five of the supermajors beating analysts’ estimates. 

Royal Dutch Shell (NYSE: RDS-A) became the latest to do so earlier today when they reported profits that doubled from the previous quarter, and that were up 631% versus the first quarter of 2016. As with the others, the primary driver was a big turnaround in the Upstream segment, driven primarily by higher oil and gas prices relative to a year ago. Yet Shell’s shares can be purchased at less than a 5% premium to their value a year ago.

But today I want to dig a little deeper. A critical metric is the amount of cash flow these companies are generating. If they can generate decent cash flow at current commodity prices, then they should be able to weather a sustained period of lower commodity prices and be well-poised to profit as oil prices stabilize above $50/bbl (which I believe they will).

I want to start with Chevron and will address BP (NYSE: BP) in the next update. For Q1 of this year, the company reported cash flow from operations (CFO) of $3.9 billion, versus $1.1 billion in Q1 2016. But then the company had capital expenditures for the quarter of $3.3 billion, and they paid out dividends of $2 billion. The company also paid back $900 million in debt during the quarter. Thus, even at oil prices that averaged $51.84 a barrel (bbl) for West Texas Intermediate (WTI) and $53.70 for Brent crude, the company experienced a funding gap of ~$2 billion for Q1. That funding gap was closed via asset sales:

Chevron sold off its geothermal business in Indonesia to close the funding gap in Q1, and already this quarter they have made about $2 billion selling assets in Bangladesh and Canada. Additional asset sales are expected to close the gap for the rest of the year, which — barring an unexpected collapse in oil prices — should get the company through the year and the completion of several megaprojects. This will further boost cash flow while allowing Chevron to reduce capital expenditures.

All in all, it looks like Chevron will continue to be able to fund its capital needs and the dividend from a combination of cash flow and assets sales, while completion and ramp-up of three megaprojects this year should enable them to close the gap without the asset sales. That all assumes that oil prices don’t recover much from here, but also that they don’t collapse back below $40/bbl.

Chevron remains a Buy for conservative investors up to $115. The 4% dividend looks safe at current oil prices, and you can pick up shares today for not much more than they were a year ago. I suspect that will no longer be the case a year from now.