BP Q4 2014 Preview: The Decline In Oil Prices and Ruble To Weigh On Upstream Earnings
BP Plc. (NYSE:BP) is scheduled to announce its 2014 fourth quarter earnings on February 3. We expect lower crude oil prices to weigh significantly on the company’s upstream earnings growth. The average Brent crude oil spot price declined by more than 30% year-on-year during the fourth quarter. This is expected to result in thinner operating margins on BP’s spot crude oil sales. In addition, the company’s consolidated upstream earnings would also be negatively impacted by the sharp depreciation of the Russian Ruble against the U.S. dollar because of its shareholding in Rosneft, Russia’s state-owned oil and gas company. However, on the downstream side, we expect an improved global refining environment and the company’s enhanced ability to convert greater amounts of heavier crude oil into refined products to boost its fourth quarter earnings. During the earnings conference call, we will be looking for an update on BP’s operating strategy under the changed crude oil price environment and ongoing legal issues associated with the 2010 Deepwater Horizon incident.
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 $47/share price estimate for BP, which is around 20% above its current market price.
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Ruble Fall To Impact Earnings From Rosneft
In 2013, BP sold its investment in TNK-BP (a joint venture between BP and AAR) to Rosneft in exchange for $11.8 billion in cash and an 18.5% stake in the Russian oil giant. [1] The transaction that raised BP’s existing equity interest in Rosneft to 19.75% was primarily a wager on the state-owned oil company’s long-term growth potential from undiscovered, technically recoverable, hydrocarbon reserves in the Russian Arctic, which are estimated to be around 214 billion barrels of oil equivalent. [2] However, sanctions imposed by the west on Moscow over the Ukrainian crisis, the depreciation of the Russian Ruble against the U.S. dollar, combined with the sharp decline in oil prices, means that BP’s upstream earnings growth could be significantly impacted because of this transaction in the short to medium term.
The most prominent impact on the company’s fourth quarter upstream earnings is expected to be that of the 47% slide in the Russian Ruble against the U.S. dollar (because of the currency translation effect). The fact that Rosneft’s debt is largely denominated in the U.S. dollar and Euro is expected to have a significant impact on BP’ earnings since it will inflate the Ruble-denominated debt burden on the Russian energy giant resulting in lower net income that it could share with its equity partner, BP. During the first nine months of 2014, BP’s cumulative share of Rosneft’s net income stood at $1.4 billion. However, we estimate the U.K. oil giant’s fourth quarter upstream earnings to decline by over $500 million because of its equity interest in Rosneft, further aggravating the impact of lower oil prices. [3]
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 fourth 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. [4]
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 January 29th, the March 2015 futures contract of the WCS crude closed at a discount of more than $13 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. [4]
Although all the major new units associated with the Whiting refinery modernization project were successfully commissioned by the end of 2013, the amount of heavy crude processing at the refinery was steadily ramped up during the first nine months of last year. The enhanced capability to refine heavier grades of crude oil, which are also cheaper, coupled with improvement in the global refining environment, has helped lift BP’s downstream margins recently. The company’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, jumped almost 15% y-o-y during the third quarter. We expect to see a similar performance during the fourth quarter as well. [5]
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Notes:- BP 2013 Annual SEC Filing, sec.gov [↩]
- Arctic Oil and Gas, ey.com [↩]
- BP Suffers As Oil Price And Russia Crisis Weigh On Rosneft Stake, ft.com [↩]
- Whiting Refinery Modernization Project, bp.com [↩] [↩]
- BP Third Quarter 2014 Earnings Call Presentation, bp.com [↩]