A merger of the two oil majors would represent the third mega-merger in the oil sector in less than a year. It would rank the combined group behind only Royal Dutch/Shell and BP Amoco.
Sources familiar with the companies confirmed that Chevron was in talks with Texaco over the weekend, after Texaco shares jumped by 8.14 per cent to 67.25 in late trading on Friday. Chevron shares, which have risen by 14 per cent since the start of the year, came off 2.93 to close at 94.88.
Both US groups have been under mounting pressure to forge an alliance since 1 December, when Exxon announced a $220bn link-up with Mobil, the biggest oil merger to date. When that merger is completed, it will catapult Exxon/Mobil to the number one slot ahead of the two British-based groups.
The Exxon/Mobil deal followed BP's merger last year with the Chicago oil giant Amoco. In March, BP Amoco became the biggest UK oil group when it announced the purchase of Arco, an ailing oil firm based on the west coast of the US.
Chevron declined to comment on the talks. A spokeswoman for Texaco said the group never commented on speculation but added: "We have been linked with Chevron in the past. We have said we are open to talking to businesses with regard to growing shareholder value."
Chevron has clearly indicated its interest in a merger. Ten days ago its chairman and chief executive, Kenneth Derr, told shareholders: "We would seriously consider any merger we think makes good economic sense for you. I can assure you we have reviewed many possibilities."
A merger would be seen in the industry as a takeover of Texaco by Chevron. Based on today's opening share price, Chevron, based in San Francisco, is valued at $62bn. Texaco, headquartered in White Plains, New York, is valued at $36bn.
Texaco already operates a joint venture with Chevron called Caltex. Caltex operates gas stations and convenience stores in more than 60 countries in Africa, Asia and the Middle East.
Last year Texaco looked set to form a partnership with Shell to combine their downstream operations in Europe. A memorandum of understanding was signed last summer but the deal collapsed by November.
Chevron, which last year saw its earnings slump 39 per cent to $3.2bn, has already earmarked $500m of cuts for 1999. Analysts calculate the merger would allow the combined group to make further savings of around $1.5bn.
However, analysts warned that a deal may take months to sign because of competition issues. Last year, Texaco launched a joint venture with Shell and the Saudi company, Saudi Aramco, to create the largest oil refiner in the US, selling 15 per cent of its gasoline.
With Chevron already the fourth-largest refiner in the US, regulators are unlikely to allow it to combine its upstream businesses with the Texaco alliance.
Adam Sieminski, an analyst with BT Alex.Brown, said: "The question is, how do you get Texaco out of the Shell, Saudi Aramco joint ventures?"
Fadel Gheit, an oil analyst with Fahnestock & Co, the investment house, said Texaco could get around the competition issues by selling its stake in the joint venture.
"If these two come together, they will give the other three supermajors a run for their money," he said.