BP Earnings Preview: Lower Oil Prices To Offset Higher Production

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BP Plc. (NYSE:BP) is scheduled to announce its 2015 first quarter earnings on April 28. 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 50% year-on-year during the first quarter. This is expected to result in thinner operating margins on BP’s spot crude oil sales. However, higher production volume because of the contribution from recently started projects, and increased entitlements as a result of lower oil prices, coupled with the company’s enhanced ability to convert greater amounts of heavier crude oil into refined products, and productivity cost savings, are expected to partly offset the impact of lower commodity prices. 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 $39/share price estimate for BP, which is around 10% below its current market price.

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Higher Upstream Production

BP has changed a lot since the 2010 Deepwater Horizon incident, primarily due to divestments made by the company in order to fund charges associated with the oil spill fiasco. By the end of last year, the company had completed divestments of around $41 billion. A majority of these asset sales primarily included upstream installations, pipelines and wells, while the company has managed to retain most of its (~90%) proven reserves. This has led to a sharp decline in BP’s production rate over the last four years. Its average daily hydrocarbon production rate fell by almost 25% since 2010 to 2,143 thousand barrels of oil equivalent per day (MBOED) last year. [1]

In order to revive its operational strength, BP started production from as many as eight new 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. More than 50% of these new projects have crossed the critical, final investment decision (FID) stage of development, and are currently under construction. This year, BP plans to start production from four of these new projects under construction. Production from these new projects is expected to more than offset the decline in BP’s base production (due to natural field declines) and result in a gradual increase in its upstream production in the long run. [2]

In addition to new projects, we expect BP’s first quarter upstream production to also increase as a result of higher entitlements from projects under production-sharing agreements (PSA). A PSA is an arrangement through which an oil company bears the risks and costs of exploration, development, and production. In return, if exploration is successful, the oil company receives entitlement to variable physical volumes of hydrocarbons, representing recovery of the costs incurred and a stipulated share of the production remaining after such cost recovery. Therefore, under such agreements, the production volume entitled to an oil company increases during the period of lower oil prices. BP derives almost one-third of its total net hydrocarbon production from production sharing agreements, and its upstream cash profits are therefore relatively less exposed to the volatility in crude oil prices. [3]

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Notes:
  1. BP 2014 20-F Filing, sec.gov []
  2. BP Upstream Analyst Day Presentation, bp.com []
  3. BP 2014 Full-Year Investor Update, bp.com []