Chevron's High Confidence Is Driving It to Wager Over $2 Billion That It Will Close This Needle-Moving Acquisition

In late 2023, Chevron (NYSE: CVX) made a bold move by agreeing to acquire Hess (NYSE: HES) for $53 billion. The transaction will enhance and extend the company's production and free cash flow growth outlook into the next decade. However, that deal hasn't closed yet because of a dispute with rival ExxonMobil (NYSE: XOM) over its lucrative partnership with Hess in offshore Guyana.

The oil giants are battling in court over the deal. Chevron is so confident it will win that it recently bought about 5% of Hess' stock on the open market, valued at over $2 billion at Hess' current $46.5 billion market cap. That investment will save it some money if it does close the deal.

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Drilling down into the dispute

The oil industry has been in the midst of a massive consolidation wave in recent years. Exxon triggered the buying binge when it agreed to acquire Pioneer Natural Resources for $59.5 billion in October 2023. Chevron followed a few weeks later with its $53 billion agreement to buy Hess. While Exxon has already closed its needle-moving purchase to bulk up on its position in the Permian Basin, Chevron hasn't completed its deal for Hess because of Exxon.

The sticking point is Hess' position in Guyana. While Hess also operates in the Bakken of North Dakota, the Gulf of Mexico (also known in the U.S. as the Gulf of America), and Southeast Asia, the bulk of its value stems from its 30% interest in the Stabroek block in Guyana. The Exxon-operated offshore oil field holds an estimated 11 billion barrels of oil equivalent resources. It produces high-margin oil and has strong growth prospects. Analysts estimate that Hess' stake in the Stabroek block represents 70% of the company's value.

Exxon believes that the primary driver of Chevron's purchase of Hess is its interest in the Stabroek block. Exxon therefore thinks the deal has triggered the change of control clause in its joint development agreement with Hess and China's CNOOC. Chevron disagreed, which led the companies to seek arbitration in the matter. The arbitration panel should rule in May.

Highly confident in its case

The Stabroek block is clearly Hess' crown jewel. It's a world-class asset that generates strong and growing free cash flow. Because Exxon has several development projects lined up to expand production in Guyana in the coming years, it's a key driver of Chevron's view that its acquisition of Hess will double its free cash flow by 2027 while extending its production growth outlook into the 2030s.

However, Hess holds a lot of strategic value for Chevron beyond Guyana. Chevron will also pick up the company's high-quality position in the Bakken, adding a third major U.S. shale position to its portfolio to complement its operations in the Permian and DJ basins. That region produces strong cash flow, backed by the integrated assets of Hess Midstream.

Adding Guyana and the Bakken would further diversify and high-grade Chevron's portfolio. Meanwhile, it would also gain complimentary positions in the Gulf and Southeast Asia. That would bolster its scale in those regions, enhancing its ability to generate free cash flow.

Hess is the total package for Chevron. It's highly strategic because it's additive to its portfolio while highly complementary to its existing assets. That drives Chevron's confidence that arbitrators will rule in its favor. The oil giant believes that they will see that it's not just buying Hess for the Stabroek block but acquiring the company because the whole operation is such a great fit for its global portfolio.

That confidence drove Chevron to scoop up nearly 15.4 million shares of Hess since the start of the year, which is just under 5% of its outstanding shares. The company made those purchases at a discount to the exchange ratio in its merger agreement, so it will save some money on the acquisition if it does close its deal. It's a bold bet because the value of Hess' stock is likely to decline if Chevron loses its arbitration hearing to Exxon.

A smart bet

Chevron firmly believes it will win its arbitration case against Exxon and close its acquisition of Hess later this year. It's putting more than $2 billion behind that belief by purchasing nearly 5% of Hess' stock on the open market. That move could pay off by saving it some money if it can close that needle-moving deal later this year, which would make it an even better acquisition.

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Matt DiLallo has positions in Chevron. The Motley Fool has positions in and recommends Chevron. The Motley Fool has a disclosure policy.