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BP - Upstream recovers, but Gulf of Mexico still a drag

Nicholas Hyett | 1 August 2017 | A A A
BP - Upstream recovers, but Gulf of Mexico still a drag

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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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Underlying profit for the first half rose 75% to $2.2bn, thanks largely to a recovery in the Upstream business, although second quarter profits of $0.7bn were lower than last year as tax costs increased. The shares rose 1.9% following the announcement.

The quarterly dividend remains unchanged at 10 cents per share.

Our View

Times remain tough for the oil industry, with oil hovering around $50 a barrel despite OPEC's best efforts to limit supply and boost prices. Consequently, the balance sheets of many producers are still under pressure.

Largely as a result of the disastrous impact of the Gulf of Mexico oil spill, BP started cutting costs and disposing of assets well before the oil price took a dive. The group has done an impressive job here, and while starting the process early may not have been voluntary, trimming fat and reducing spending means that it is now in a healthier position than many rivals.

Unfortunately the compensation payments from the Deepwater Horizon spill continue to make significant demands on the group's cash flow. The total cost of the spill is expected to be north of $60bn and while payments should decline from here, they have left the group scarred with a hefty debt pile that will need to be got under control.

Nonetheless, BP's management seem to have an eye on the future, with recent acquisitions improving its long term production potential and new projects being given the green light. Cash flow should improve in the medium term as production ramps up.

These new projects will require increased investment in the near term. As a result, the level at which BP expects to match sources and uses of cash in 2017 has increased to $60 a barrel (from $50-$55 a barrel previously) - a level we haven't seen since July 2015.

The group's $7bn plus dividend is clearly a burden, with more than a third being paid in shares, and debt continues to climb. Neither is a viable long-term solution, and with the shares currently offering a prospective yield of 6.6% by 2018 the market is obviously nervous.

We feel that BP is making progress, and is certainly leaner. Declining Gulf of Mexico costs should free up cash to get debt back under control, and guarantee investment in future production while maintaining the dividend. Of course, all of that is predicated on a stable or higher oil price. BP wouldn't be well placed to weather another collapse.

First Half Results

The Upstream division, which includes BP's oil exploration and production units, saw underlying profits before tax jump from $29m in the second quarter of 2016, to $710m this quarter.

The dramatic improvement in performance reflects a 6% increase in production and 18% reduction in unit production costs across the half. BP also benefitted from an improving price environment, with the average price across all hydrocarbons rising from $28.66 per barrel of oil equivalent (boe) in Q2 2016, to $33.59 in Q2 2017.

Underlying profits before tax in Downstream, which covers refining, chemicals and fuel sales, fell 7% to $1.4bn in the second quarter. BP's stake in Rosneft contributed $279m to group profits before interest and tax in Q2.

Operating cash flows in quarter were $6.9bn, falling to $4.9bn once the Gulf of Mexico oil spill payments are taken into account. Were it not for these payments, which are expected to fall from the second half, organic cash flow would have exceeded organic capital expenditure and dividends paid by $0.6bn.

As it is, gearing at the end of the half rose 4.1 percentage points to 28.8%, although this remains within the 20-30% target range. Net debt hit $39.8bn compared with $30.9bn a year ago.

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