BP Q3 Earnings: Low Oil Prices Negate The Positive Effects Of Increased Upstream Production And Higher Downstream Margins
BP Plc. (NYSE:BP) released its Q3 2015 earnings report recently. [1] The decline in upstream earnings more than offset the improvement due to higher downstream margins and increased upstream production. Overall, if we look beyond the volatility in commodity prices, the key takeaway from BP’s first-quarter earnings release was the visible improvement in its upstream production and downstream margins. However, the company has been hit hard by the current downtrend of low crude oil prices and its average price realizations in both upstream and downstream segments have suffered as a result. BP is taking measures to reduce its capital spending and overall cost structure in order to be able to better steer through this commodity trough. We believe that these measures will be beneficial in lifting the company’s cash profit margins as oil prices recover gradually in the long run.
Our price target for BP stands at $41, implying a premium of more than 15% to the market.
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Upstream Production Increases, But Oil Prices Hurt BP’s Average Realizations
There has been a sharp decline in BP’s upstream production rate over the past few years. The company’s average daily hydrocarbon production amounted to 2,143 thousand barrels of oil equivalent per day (MBOED) last year, down almost 25% from 2010 levels. [2] The decline in upstream production is a byproduct of divestitures made by the company in order to fund charges associated with the 2010 Deepwater Horizon incident. By the end of last year, the company had completed divestistures of around $41 billion. While the company has managed to retain most of its (~90%) proven reserves, a majority of the asset sales have included upstream installations, pipelines and wells, which has hurt BP’s upstream production. However, the company has managed to buck the downward trend and upstream production has increased by 4.3% during the first nine months of 2015 as compared to the prior year period. [2] This improvement is a direct result of the 15 new projects BP brought online during the 2012-2014 period, a conscious effort on the part of the company to increase production. With 2014 start-ups now reflected in BP’s production, the company expects new projects between 2015 and 2020 to bring in over 800,000 bpd of additional production by 2020. [3]
The extended period of low crude oil prices has hurt the company’s upstream operations in 2015. Even though BP has increased daily hydrocarbon production, the company’s average price realized per barrel from liquids for the year so far has dropped to $49 as compared to $88 for the whole of 2014. [2] The average crude oil price has remained below $60 for the year to date and we believe that prices will not experience any significant recovery for the rest of the year due to the ongoing production related stand-off between OPEC and Non-OPEC producers. Consequently, we believe that BP’s Average Crude Oil & NGLs Sales Price will amount to less than $50 for the year 2015 and will subsequently witness a gradual recovery throughout our forecast period.
Consistent Improvement In Downstream Margins
BP’s downstream margins have improved in the recent past because of the improvement in the refining environment in general, and increased refinery optimization by the company. Consequently, BP’s downstream RC profit before interest and tax has increased by more than 100% for the first nine months of 2015 as compared to the year ago period. [2] 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, increased by 23% year over year to $18.20 per barrel for the year so far. In addition to higher refining margins, the company’s downstream earnings were also boosted by a strong performance from its supply and trading business. Going forward, we expect BP’s downstream margin to continue to improve in the long run since the company is targeting significant efficiency improvements in its refinery business. It plans to enhance its feedstock advantage in the U.S. by increasing the proportion of cheaper crude oil — primarily from Canadian oil sands and the Bakken shale — processed by its refineries from around 70% currently to almost 90% in the medium term.
Increased Focus On Controlling Capex, Divestment And Cutting Costs Amid Lower Oil Prices
Controlling capital expenditures while maintaining modest growth prospects is the highest priority for BP right now, primarily due to the changed crude oil price environment. In the past few years, the company’s total capital expenditures have increased from around $20.3 billion in 2009 to almost $23.8 billion in 2014. [2] However, the recent decline in global crude oil prices has forced BP to increase its focus on optimizing both capital and operational costs in order to maximize its return in the current commodity down cycle. The company is now projecting its organic capital expenditure for 2015 to be around $19 billion, down from the previous projection of just under $20 billion. [1] BP further expects capital expenditures to remain in the range of $17-19 billion per year till 2017. The company is also progressing nicely on its $10 billion divestment target for 2015, having completed almost 80% of the target by the end of the third quarter. BP plans to divest assets worth $3-5 billion next year before returning to a divestment rate of around $2-3 billion a year thereafter.
The company’s projections are in line with our expectation for BP’s Net Upstream CapEx. We expect the figure to decline in absolute terms for 2015, as the company continues to reduce capital spending and make progress on its ongoing divestiture plan. However, the figure as a % of revenue will go up due to the significant decline in 2015 revenues. Beyond 2015, we expect Net CapEx % of Upstream Revenue to gradually decrease throughout our forecast period. In addition to lower net capital spending, the company is also targeting significant efficiency improvements in its operations. BP reduced controllable cash costs by $3 billion over the first nine months of 2015 as compared to the prior year period. [1] The company plans to build on its cost cutting drive and expects to reduce 2017 annual cash costs by over $6 billion as compared to 2014 levels.
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