BP Earnings Preview: Lower Upstream Production, Thicker Downstream Margins Expected
BP Plc. (NYSE:BP) is scheduled to announce its 2014 third quarter earnings on October 28. We expect lower crude oil prices to weigh on the company’s upstream earnings growth. Benchmark crude oil prices have declined sharply over the past few weeks on rising supplies and falling demand growth estimates. The average Europe Brent crude oil spot price declined by almost 8% year-on-year during the third quarter. In addition, we also expect BP’s upstream earnings to be negatively impacted by lower hydrocarbon production, primarily due to the Abu Dhabi onshore concession expiry in January this year and planned turnaround activities at its higher-margin upstream projects in 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 third 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 $54 price estimate for BP, which is around 25% above its current market price.
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Lower Oil Prices and Production To Weigh On Upstream Earnings
We expect BP’s upstream earnings to decline on lower crude oil prices and hydrocarbon production. Benchmark crude oil prices have declined sharply over the past few weeks on rising supplies and expectations of slower demand growth. Reuters reported recently that OPEC’s (Organization of the Petroleum Exporting Countries) crude oil supply last month rose to its highest point since November 2012 on a recovery in Libya and higher output from Saudi Arabia, the world’s main producer for crude oil. [1] Global benchmark crude oil prices reacted sharply to the news, as it came at a time when the tight oil revolution in the U.S. is already causing a supply glut in one of the world’s largest importer of the black gold. Moreover, earlier this month, the International Energy Agency (IEA) in its latest monthly report also cut its forecast for the growth in global oil demand this year. It now expects global oil demand, which stood at around 90.5 million barrels per day last year, to increase by just around 0.7 million barrels per day this year. [2] The price of front-month Brent crude oil futures contract on the ICE has declined by more than 25% since hitting a short-term peak in June and is currently trading at around $86/barrel. [3]
In addition to lower crude oil prices, lower hydrocarbon production is also expected to weigh on BP’s upstream earnings during the third quarter. We expect the company’s oil and gas production 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. [4]
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 half of this year, BP’s average daily hydrocarbon production declined by around 7.3% y-o-y, primarily due to the expiry of the Abu Dhabi concession agreement. We expect to see a similar impact on volumes during the third quarter as well. [5]
Thicker Refining Margins To Boost Downstream Earnings
On the downstream side, we expect the full impact of the Whiting refinery modernization project to boost BP’s third 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%. 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.
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 October 24th, the December 2014 futures contract of the WCS crude closed at a discount of more than $15 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. [6]
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. During the second quarter earnings call, BP officials announced that the ramp-up of heavy crude refining capacity at its Whiting refinery is progressing well. At the end of the quarter, it was processing 270,000 barrels of heavy crude oil per day. The enhanced capability to refine heavier grades of crude oil, which are also cheaper, has helped BP improve its refining margins. During the second quarter, BP’s average refining marker margin (RMM), which is a measure of the difference between the price a refinery pays for its inputs (crude oil) and the market price of its products, was up almost 16% and 40%, compared to the first quarter of this year and the last quarter of 2013, respectively. [5] We therefore believe that the company’s second half downstream results would be significantly be better than last year. (See More: BP Set To Start Processing More Of Cheaper Canadian Crude At Its Whiting Refinery)
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Notes:- Oil Futures Slide Sharply On Supply Worries, wsj.com [↩]
- Oil Prices Continue To Slide On IEA Report, bbc.com [↩]
- Ice Brent Crude Oil Front Month, ft.com [↩]
- Abu Dhabi to Run Onshore Oilfields as Foreign Tie-Ups End, bloomberg.com [↩]
- BP Second Quarter 2014 Earnings Call Presentation, bp.com [↩] [↩]
- Whiting Refinery Modernization Project, bp.com [↩]