BP Earnings Preview: Lower Production Volume, Improvement In Refining Margins Expected

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BP Plc. (NYSE:BP) is scheduled to report its 2014 second quarter earnings on July 29. Average Europe Brent crude oil prices were up by around 7% year-on-year during the second quarter and will positively impact the company’s crude oil revenues. However, we expect BP’s upstream earnings to be negatively impacted by lower hydrocarbon production volume, primarily due to Abu Dhabi onshore concession expiry in January this year and planned turnaround activities at its higher-margin upstream projects in the North Sea and the Gulf of Mexico. On the downstream side, we expect higher crude distillation capacity and the ability to convert greater amounts of heavier crude oil into refined products to boost BP’s second quarter earnings. During the earnings conference call, we will be looking for an update on the ongoing legal issues associated with the 2010 Deepwater Horizon incident. (See: BP’s Downside Risk From Climbing Oil Spill Expenses)

Headquartered in London, BP is one of the world’s leading oil & gas multinationals with operations in more than 80 countries. As a vertically integrated oil and gas major, it has both upstream as well as downstream operations. The upstream division primarily includes exploration and production activities for oil and gas, while the downstream division focuses on producing refined petroleum products such as gasoline.

We currently have a $53.5 price estimate for BP, which is almost 5% above its current market price.

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Higher Prices, Lower Production Volumes To Drive Upstream Results

We expect BP to report a mixed set of second quarter numbers on the upstream side, as commodity prices were up during the period but the company’s production volume is expected to be lower, primarily due to the expiry of the Abu Dhabi onshore concession agreement. The company lost its 75-year rights to the emirate’s oldest producing fields this January, when the Second World War-era contract expired. These oilfields together account for around 50% of Abu Dhabi’s total oil output (almost 3 million barrels per day) and hold more than a 100 billion barrels of oil and oil equivalent. [1]

Until a new concession agreement is signed, Abu Dhabi National Oil Company (Adnoc) will be the sole-risk shareholder of the Abu Dhabi Company for Onshore Oil Operations (Adco), the current concession’s joint-venture operator. As a result, BP and other foreign oil companies, which were previously involved in the concession, will not be able to lift equity oil or book reserves from these oil fields. During the first quarter, BP’s average daily hydrocarbon production rate declined by around 8.5% y-o-y, excluding Russia, primarily due to the expiry of the Abu Dhabi concession agreement. We expect to see a similar impact on volumes during the second quarter as well. [2]

Higher Refining Capacity, Thicker Margins To Boost Downstream Earnings

On the downstream side, we expect the full impact of the Whiting refinery modernization project to boost BP’s second quarter earnings. BP began the Whiting refinery modernization project in 2008 in order to enhance the refinery’s heavy crude processing capacity from around 20% up to 85%. In other words, the upgrade increased its Canadian crude processing capacity from 85,000 barrels of oil per day (bpd) to 350,000 bpd, though the plant’s overall capacity remained the same. [3]

The Western Canadian Select (WCS) crude trades at a discount to the WTI and the Brent crude. This is primarily due to a glut of supply from the Canadian oil sands, a lack of pipeline infrastructure to the gulf coast as well as a higher proportion of impurities present in the WCS.  On July 24th, the September 2014 futures contract of the WCS crude closed at a discount of more than $23 per barrel to the WTI. BP’s Whiting is the largest refinery in the Midwest region that has access to this cheaper, albeit heavier crude oil from Canada. The company’s decision to undertake a more than $4 billion modernization project of the Whiting refinery was primarily driven by this favorable feedstock scenario. BP expects to generate incremental cash flows of ~$1 billion annually from the project.

Although all the major new units associated with the Whiting refinery modernization project were successfully commissioned by the end of last year, the amount of heavy crude processing at the refinery has been ramping up during this year. At the end of the first quarter, the refinery was processing about 200,000 barrels of heavy Canadian crude oil per day. This figure is expected to have reached around 280,000 bpd by the end of the second quarter. This leads us to believe that although the global refining environment continues to remains weak because of industry overcapacity, there could potentially be some respite for BP’s shrinking downstream margins during the second quarter. Also, since BP completed the upgrade of the largest crude processing unit at the Whiting refinery in July 2013, which had been shut down since the fourth quarter of 2012, we expect to see a meaningful year-on-year improvement in the company’s second quarter refining throughput. [2]

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Notes:
  1. Abu Dhabi to Run Onshore Oilfields as Foreign Tie-Ups End, bloomberg.com []
  2. BP 2014 Q1 Earnings Presentation, bp.com [] []
  3. Whiting Refinery Modernization Project, bp.com []