How Does BP Plan To Manage Its Operating Margins In The Current Commodity Downturn?

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Unlike most of its peers, BP Plc. (NYSE:BP), the UK-based integrated oil and gas company, has strongly held its ground in the current commodity downturn. Although the company experienced a sharp drop in its revenue and profitability last year, its stock price has recovered almost 18% since the beginning of the year. The major reason behind this is the company’s exposure to high quality oil and gas assets, and its significantly lower production costs compared to its counterparts. In this article, we discuss BP’s strategy to sustain its operating margins even in this weak oil price environment.

We currently have a $36 per share price estimate for BP, which is in line with its current market price.

See Our Complete Analysis For BP Plc. Here

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Lowering Production Costs

As mentioned earlier, BP has a strong cost advantage over its peers. The company’s production cost, which accounts for more than 15% of its total operating costs, is notably lower than its competitors. While the company’s production cost per barrel of oil equivalent (BOE) almost doubled between 2010 and 2013, it continued to be substantially lower than its close rivals, such as ExxonMobil, Royal Dutch Shell, and Chevron. However, with the onset of the commodity slowdown in 2014, the company proactively worked towards improving its operational efficiency and control its production costs. As a result of these efforts, BP managed to cut its 2015 production cost to under $10 per BOE, reducing it by roughly 20% compared to 2014. Further, the oil and gas producer aims to further bring down its cost closer to $8 per BOE, representing a decline of about 15% in this year. By doing this, BP will not only maintain its cost lead over its competitors, but will also enhance its cost structure such that it can sustain its operating margins in the prevailing low price environment. In addition, the company believes that 75% of these cost reductions are sustainable and will boost its profits when the commodity prices rebound.

BP-Q&A-2-1

Source: BP’s Cost And Capital Efficiency Presentation, June 2016

Reducing Upstream Headcount

One of the obvious byproducts of a slowdown is layoffs. A similar trend has been witnessed in the oil and gas industry over the last few quarters, where companies, both large and small, laid off hundreds of employees in order to weather the ongoing commodity trough. BP, which had a workforce of close to 30,000 people at the peak of the commodity cycle in 2013, reduced its headcount drastically over the last two years to manage its personnel costs. With the continued uncertainty in the commodity markets, the company plans to further cut down its workforce to 20,000 people at the end of 2016. Since personnel cost forms more than 25% of BP’s cash costs, a one-third reduction in the company’s headcount will result in notable cost savings, which will augment its diminishing operating margins.

BP-Q&A-2-2

Source: BP’s Cost And Capital Efficiency Presentation, June 2016

These cost reduction measures will enable the BP to bring down its cash costs by approximately $4 billion over the time frame of 2014 to 2017, which will allow the company to weather the commodity down cycle more efficiently.

Investing In New Projects With Higher Margin But Lower Cost

Apart from managing its operating costs, BP is investing judiciously in projects that add more value to its portfolio at lower costs. The company has a strong pipeline of projects that are expected to add a production capacity of approximately 800 MBOED (thousand barrels of oil equivalent per day) by 2020. Almost 85% of these planned projects are either under construction or are already operating. While these projects will increase BP’s production capacity, they are estimated to operate at much lower development costs compared to the company’s existing portfolio. This is likely to enhance the London-based company’s operating margins by as much as 35% over the next five years, assuming oil prices average at around $52 per barrel throughout the period.

BP-Q&A-2-5

Source: BP’s Upstream Investor Field Trip, 2016

Thus, we believe that though the slump in commodity prices has upended BP’s revenues, the company is leaving no stone unturned to sustain its profitability in this downturn.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for BP

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