Deepwater Horizon

Amid mounting Deepwater Horizon costs and a 2-year slump in oil prices, BP has continued to restructure its portfolio, reduce cost, and rebalance its cash flow.  BP has made strategic shift to reduce its non-core upstream business (exploration and production) to the more profitable downstream business (refinery and trading).

BP expects to spend about $17 billion on finding and producing oil in 2016, significantly down from $23 billion in 2014.  BP has also divested half of its US capacity by selling the refineries in Carson, CA and Texas City, TX, and sold many North Sea oil and gas fields and its Yacheng gas field in the South China Sea.

On May 19, 2016, BP announced that it had sold an 11.5% stake in Castrol India.  It is expected that the divestment program will amount to a level in the range of $3 billion to $5 billion in 2016, and $2 billion to $3 billion in 2017.

BP’s upstream segment, which contributed 24% to its URC (underlying replacement cost) EBIT in 1Q15, has turned into a loss of -$747 million in 1Q16.  On the other hand, while falling 16% over 1Q15, BP’s downstream refining and marketing arm’s URC EBIT produced $1.6 billion in 1Q16, which kept overall earnings positive at $0.99 billion.  By the way, this changing P&L segment dynamics is prevalent in the industry.  Total S.A.’s (TOT), Suncor Energy (SU), and ExxonMobil’s (XOM) all saw similar losses in their upstream segments in 1Q16.  Refining margins were at their lowest level for over five years.

The so called “strategic” shift may have been a knee jerk reaction to the deteriorating macro picture.

The drastic portfolio restructuring, or assets sales, has raised risk concerns of BP’s future production performance if and when the refinery environment strengthens.  BP’s increasing reliance on Russia, after its reduction in the U.S. capacity, is also worrisome.  As Russia is the second largest contributor to BP’s production and earnings, next to the U.S., the increasingly realistic Russian sanctions will undermine BP’s operation.  Furthermore, BP holds a 19.8% equity stake in Rosneft, Russia’s largest oil company.  Although its contribution to BP’s total earnings fell from $183 million in 1Q15 to $66 million in 1Q16, the positive cash flow has been considered one of the reasons that BP was able to keep paying $0.10 dividend a share.

To combat falling oil prices, BP seeks to lower its cost structure.  This has been achieved by moves such as freezing executive compensations, cutting 7000 jobs, and reducing capital expenditure to $17 billion by 2017.  By next year it expects its cash costs to be $7 billion lower than for 2014, allowing the company to balance its spending and cash flow at assumed oil prices of $50 to $55 a barrel.

Over the past 12 months, costs are already down $4.6 billion compared to 2014.  Citing “the commitment to sustaining dividend” is the primary near-term goal to cut spending and rebalance cash flow.  Although, at its recent annual meeting, BP’s chairman Carl-Henric Svanberg warned that dividend may be lowered if energy prices remain under pressure for longer than expected.

That being said, BP’s efforts to cut costs appear to make progress. For 1Q16, BP reported a replacement cost loss of $485 million.  Net of the Deepwater Horizon costs of $917 million, it has a profit of $532 million, vs. estimate of -$140 million.  BP shares jumped 4%.

Talk about Deepwater Horizon disaster: to this date, the disaster has charged BP $56.4 billion.  It has changed the course of BP permanently.  The spill forced the company to sell more than $40 billion in assets, restructure the business around a smaller set of high-value oil and gas fields, and entered a $20 billion settlement with the U.S. government resolving nearly all legal claims arising from the accident.

But it is far from over yet. The company still faces additional civil litigation and ongoing costs related to the disaster, including an annual liability of around $1 billion that may stretch out over two decades. BP said that it still can’t “reliably estimate the remaining liability.”  As a result, for Deepwater Horizon cost alone, BP stocks have underperformed their peers, Exxon and alike, by at least 60% since April 2010.  It equates to BP shareholders’ loss of $150 billion, which is far more than any estimates on the liabilities or the amount already settled, $76.4 billion.

Even if stock market is not easily forgiving, this may imply BP a good buy.



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