BP’s Earnings Show Surprising Strength

by Trefis Team
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BP Plc (NYSE:BP) announced its third quarter earnings on October 30. The UK oil & gas giant posted surprisingly good results in a quarter marked by a number of asset sales, including the sale of its 50% stake in TNK-BP to Rosneft. Net earnings comfortably beat most analyst estimates, primarily driven by strong performance from the downstream segment; however, this was partially offset by weak performance from the upstream segment owing to lower production and realized prices.

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Upstream performance down due to lower oil & gas prices and production

Net production for the quarter declined compared to the same quarter in the prior year. This was primarily due to the sales of a number of oil & gas producing assets in order to generate cash to settle expenses related to the 2010 Gulf of Mexico oil spill. However, in a measure which excludes the impact of these divestments, net production grew y-o-y, with major startups such as the Devenick project in the North Sea and improved operating performance in Angola having a positive impact.

Upstream revenues also felt the impact of lower oil & gas prices – BP’s average price realization for oil & gas fell this quarter on a y-o-y basis, primarily reflecting lower prices in the US. Overall, upstream revenues for BP’s consolidated subsidiaries fell 6.8% compared to the same quarter in the prior year. The division’s underlying replacement cost (RC) profit, an IFRS measure which excludes the impact of non-operating items, fell by 30.5% y-o-y.

Downstream profits boosted by higher refining margins and improved operating performance

The downstream segment reported exceptional profit growth – underlying RC profit for the division grew to $3 billion, an increase of 80% compared to the same quarter in the prior year. This was primarily due to outstanding performance from the Fuels division, which reported the highest refining throughput in seven years. The division also saw unusually high refining margins of $19.50 per barrel driven by refinery closures in the Atlantic basin and low gasoline and diesel inventories globally.

The company has set up deals to sell a number of its downstream assets over the course of this year, including the Carson refinery in California and the Texas City refinery. These transactions are expected to be completed by early-mid 2013. Beyond this, we can expect to see a substantial reduction in refinery throughput, and hence downstream revenues. Further, the company has said that the high refining margins realized this quarter are unlikely to be repeated going forward.

Rosneft deal and 10 point plan

Earlier this quarter, BP agreed to sell its 50% stake in TNK-BP to Rosneft, a deal which would net BP $12.3 billion in cash and a 19.75% stake in Rosneft. Rosneft has also agreed a deal with BP’s partners in TNK-BP, AAR, to buy out their stake as well, thus gaining 100% control of TNK-BP. This would make the Russian firm the world’s largest oil & gas company in terms of reserves.

BP stands to benefit hugely from this deal, both in terms of dividend income from a rapidly growing Rosneft as well as the potential to work with the Russian company to explore and develop the vast untapped energy reserves in Russia.

Last year, BP outlined a 10 point plan which focused on putting the company back on the right path following the 2010 Gulf of Mexico disaster. One year since, the company seems to have made progress, especially with regards to its divestment strategy. It had originally set a target of generating $38 billion from divestment, and has sold assets worth around $35 billion in total to date. In spite of such large asset sales, the company has managed to avoid drastic reduction in its reserves and production, selling most of its Upstream installations, wells and pipelines instead.

BP has also set up a number of upstream opportunities going forward, accessing over 400,000 square kilometers of acreage since 2010 and opening up new exploration opportunities through deals with governments (blocks and licenses awarded in Venezuela and Brazil) or other oil companies (Reliance in India). While these projects may result in a substantial upside to the company’s oil & gas production in the long term, it will need to spend large capital expenditures in order to realize this. BP spent $16.5 billion in capital expenditures, around 65% of EBITDA, over the past nine months. We project this to gradually decrease to around 51% by the end of our forecast period.

We will be updating our $46 price estimate for BP based on the earnings release.

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