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Investment Overview for BP (NYSE:BP)
WHAT HAS CHANGED?
- Increased focus on cost optimization in a low oil price environment
Because of the recent decline in global crude oil prices, BP has significantly increased its focus on optimizing both capital and operational costs in order to maximize its return in the current commodity down cycle. The company has slashed its short to medium term capex budget by about 20% and is aggressively renegotiating drilling, servicing, and other upstream contracts with suppliers. In addition to lower net capital spending in its upstream business, where the company is prioritizing value over volume, BP is also targeting significant efficiency improvements in its downstream business. The company plans to deliver annual cost savings of around $1.6 billion from its downstream operations by 2018, versus a 2014 baseline.
- Settlement agreement with the U.S. government
BP recently agreed to pay more than $20 billion, spread over a period of 18 years, to settle all federal and state claims arising from the 2010 Deepwater Horizon oil spill incident. According to our estimates, BP’s net present liability arising from the settlement is around $6.9 billion. In our valuation model, we have treated post-tax cash flows arising from the settlement agreement (lying within our forecast period) as a cash expense, and added the discounted present value of the payments lying outside our forecast period to the company’s current outstanding long-term debt.
Below are key drivers of BP's value that present opportunities for upside or downside to the current Trefis price estimate for BP:
- Average Crude Oil & NGLs Sales Price: BP's average liquids sales price decreased from $90.20 per barrel in 2008, to $56.30 per barrel in 2009, as the world faced one of the worst economic downturns in recent decades. The global economy recovered, pushing BP's average realized liquids price to $73.40 in 2010, while various factors (including economic conditions and geopolitical unrest) pushed prices up above $100 in 2011, and kept prices high through 2012 and 2013, as well. However, recently, global benchmark crude oil prices have declined sharply on slower demand growth and rising supplies. According to the International Energy Agency's (IEA) estimates, the growth in global oil demand hit a 5-year low in 2014. This coincided with record growth in crude oil supply from non-OPEC countries, primarily the U.S., at 1.9 million barrels per day. As a result, the price of the front-month Brent crude oil futures contract on the ICE declined by around 50% in the second half of 2014. Consequently, BP's Average Crude Oil and NGLs Sales Price declined to almost $88 per barrel in 2014. We currently believe that the recent decline in oil prices could sustain for a longer period amid slower demand growth, and the diminishing price-controlling power of the OPEC. According to our estimates, BP's average liquids sales price figure could bottom out at around $47 per barrel in 2015, and rise back to around $75 per barrel by 2022. However, if a faster than expected increase in the demand for crude oil from developing countries, and a sharper than expected cut in non-OPEC supply growth leads to a quicker bottoming out process, and crude oil prices reach $100/barrel by 2022, there could be a 10% upside to our current price estimate for BP.
- Refining and Marketing EBITDA Margin: Historically, BP's Refining and Marketing EBITDA margin has hovered around the 2-3% mark, fluctuating slightly depending on the trends in global refining margins and the average price of oil realized in a given year. However, in 2013 and 2014, the company's downstream EBITDA margins dropped to just around 1.52% and 1.54%, respectively, due to industry overcapacity. Going forward, we expect margins to gradually increase to around 3.1% in the long run, primarily driven by improved refining environment & production mix, higher trading income due to increased volatility in crude oil prices and efficiency improvements in the refining business. However, if continued overcapacity in the global refining industry weighs on BP's plans to improve its downstream profitability and its Refining and Marketing EBITDA Margin increases to just around 2% in the long run, there could be a 10% downside to our current price estimate for BP.
For additional details, select a driver above or select a division from the interactive Trefis split for BP at the top of the page.
BP is one of the world’s leading oil & gas companies with operations in more than 80 countries, providing customers with fuel for transportation, energy for heat and light, retail services, and petrochemical products for everyday items.
As a global player, BP's operations and activities are held or operated through a variety of structures including subsidiaries, jointly controlled entities, or associates established which are subject to the legal systems of many different jurisdictions. The company's operations cover two main business segments: Exploration & Production (or Upstream) and Refining & Marketing (Downstream). BP also has some presence in the alternative energy space through its activities in biofuels, wind, solar, hydrogen power, and carbon capture and storage (CCS).
Large base of proved reserves
Proved reserves is an extremely critical metric for an oil and gas exploration and production company. It represents the total quantity of technically and economically recoverable oil and gas reserves owned by the company at a given point in time. It directly impacts the company's production growth outlook. At the end of 2014, BP's total proved reserves stood at over 17.5 billion oil-equivalent barrels (both developed and undeveloped). This equates to almost 15.5 years of reserve life at last year's average production rate. These reserves consist of 56% more-profitable liquids (crude oil and natural gas liquids) and 44% natural gas.
New upstream projects to drive higher profitability
BP started production from as many as eight new upstream projects in 2012 and 2013. Last year, the company brought another seven new upstream projects online. These projects contributed significantly to the 2.2% y-o-y growth in its underlying oil and gas production in 2014. Currently, the company is working on several new projects that are expected to bring online over 900 MBOED of cumulative production – net to BP – by 2020. These new project start-ups are not only expected to boost BP's upstream production volume but also operating margins, because it expects cash operating margin from these new projects to be twice as much of its average upstream margin as in 2011.
Increasing costs associated with upstream activities
BP's upstream capital expenditure has not increased over the past 3-4 years since it has been focusing on settling liabilities associated with the 2010 Deepwater horizon incident. However, the oil and gas industry as a whole has witnessed a surge in development costs. For example, Exxon’s capital expenditures have soared from around $18 billion in 2005 to over $38.5 billion in 2014, while its total hydrocarbon production has remained relatively flat over the last decade. This is a clear indication of how difficult the oil drilling business has become over the years. This has been primarily due to the increasing complexity of upstream projects. Various oil companies have embarked on different projects to extract oil such as deepwater, GTL, oil sands, etc. This has led to longer development timelines which have in turn resulted in higher costs. BP expects to spend around $19-21 billion on leasing rigs, floating oil platforms, installing pipelines, and repairing oil-refineries this year.
It is estimated that a large part of the world's oil reserves have already been discovered. Recent statistics have indicated that global consumption has been outpacing reserve additions. Peak oil is a commonly used term to describe the point at which world oil output will reach a maximum and decline afterward.
However, many institutions, such as the International Energy Agency (IEA), believe that peak oil will not occur for another 25 years at the very least. Many governments across the world are promoting alternative energy measures to ensure that the supply and demand of energy will be met at all times to come.
Improvements in technology
Due to limited underlying growth in product demand, there has been an increase in recent years towards increasing the complexity of refineries rather than expanding capacity. In the U.S., no new refineries have been built since 1980, however, improvements in process design and technology have seen capacity increase around 1% per year.
The early refineries that were established were mainly used to process light sweet crude resulting in an increase in demand for light sweet crudes. As a result of higher oil prices in recent times, heavy crude oil is becoming more economically attractive. In addition, the interest in the development of new cost effective methods for extracting and transporting heavy crude oil for refining into valuable light and middle distillate fuels is also increasing.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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