BP Q2 Earnings Preview: Lower Oil Prices To Overshadow Production Growth
BP Plc. (NYSE:BP) is scheduled to announce its 2015 second quarter earnings on July 28. [1] 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 almost 44% year-on-year during the second 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 $45 per share price estimate for BP, which is around 20% above 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. [2]
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. During the first quarter, BP’s net upstream production, excluding Russia, grew by 8.3% year-on-year. [3]
However, some of that increase in its net oil and gas production could be attributed to 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 therefore, variable entitlements have quite a visible impact on its reported upstream production when oil prices are volatile. The company’s net oil and gas production, adjusted for changes in entitlements and portfolio impacts, grew by 3.7% year-on-year, primarily driven by the ramp-up of recently-started projects. We expect to see a similar production growth during the second quarter. [4]
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Notes:- Financial Calendar, bp.com [↩]
- BP 2014 20-F Filing, sec.gov [↩]
- BP 1Q 2015 Financial Statements, bp.com [↩]
- BP 1Q 2015 Earnings Call Presentation, bp.com [↩]