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BP Q3 - Adapting to lower oil prices

Steve Clayton | 27 October 2015 | A A A
BP Q3 - Adapting to lower oil prices

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BP Plc Ordinary US$0.25

Sell: 507.20 | Buy: 507.40 | Change 2.60 (0.51%)
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BP has announced third quarter results showing underlying replacement cost profits of $1.8bn, down from $3.0bn a year earlier, but $0.5bn above last quarter's level. They have set out a new medium term financial framework that aims to balance organic cash flows by 2017, assuming a Brent oil price of around $60, compared to current levels closer to $45.

An unchanged quarterly dividend of 10c per share, to be paid in December was declared. UK investors will receive the dividend in sterling, translated at the exchange rate ruling at the time.

The group suffered the impact of lower energy prices during the quarter, but benefitted from a strong downstream environment. The group expects to complete its divestment programme for the year, with around $10bn of proceeds realised, versus $7.8bn to date. Future years will see a further $3-5bn raised next year, with $2-3bn per annum thereafter. These funds will help BP to manage oil price volatility and also the company's ongoing financial commitments stemming from the Gulf of Mexico 2010 oil spill, which has so far cost BP $55.0bn.

Capital expenditure and operating costs are being reduced aggressively. Current year capex is now set to come in around $19bn, a further $1bn reduction during the quarter. Thereafter, annual capex of $17-19bn is envisaged. A year ago, BP was budgeting to spend around $25bn. At the operating level, controllable cash costs were $3bn lower in the first nine months than in the previous year. By 2017 BP expect to have taken $6.0bn a year out of the cost base, versus the 2014 run rate.

BP will allow itself a degree more leverage, now that the bulk of costs related to the oil spill are behind it. Gearing of around 20% will be targeted, versus a 10-20% target range adopted after the spill in 2010.

Chief Exec Bob Dudley talked about having "decisively reset BP for a sustained period of lower oil prices". The results of this action are coming through well, he said and the company was now moving to rebalance their financial framework to underpin "our strong priority of sustaining our dividend and then growing free cash flow and shareholder dividends over the long term".

BP's stock price responded to the news by rising around 1-2% in early trading.

Our view:

Investing in BP these days is a statement of confidence in the strength of future oil demand, and a belief that the oil industry will not be able to meet that demand at today's low oil prices.

With the Q3 figures, BP has given the market some clarity on how it hopes to balance the books in the future. The good news is that it is confident that it can lower its cost base by $6bn per annum and reduce its capex bill by at least the same amount each year. Perhaps the chancellor should pop over to St James Square and ask them how it is done?

The bad news is that their plans still assume a recovery in oil prices, albeit only so far as $60 per barrel. In other words, even after all the effort, all the cutting and the laying off, BP will still be depending on an uncontrollable commodity price to balance the books.

BP are strongly reiterating the commitment to the dividend, even raising the prospect of growing it in future. That though looks very likely to require a more favourable oil price environment than we have today.

Over the next few years BP have a string of projects due to come on stream, which ought to support future cash-flow. Disposals look set to be more piecemeal in the future, but will provide some degree of leeway. But the expected $2-3bn a year of proceeds only represents around a third of the annual dividend bill.

BP deserve credit for taking the actions they have, as swiftly and as surely as they have. The dividend yield is over 6.5% (variable and not guaranteed) which looks attractive in the context of current interest rates. Ultimately though, that yield is only as good as the oil price. If that stays down at $45, or even goes lower, BP will have to make further, even deeper cuts, until finally it will think the unthinkable.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.