BP (NYSE:BP) has had every right to be one of the more pessimistic voices in the oil and gas industry over the past several years. Its lower return rates and the immense amount of uncertainty around the Deepwater Horizon spill meant that the company had to be very conservative in how it spent its money and how to get more from its existing portfolio.
Today, though, the company is in better shape thanks to some shrewd cost-cutting and shedding billions of dollars' worth of assets. As a result, BP's management has gone from pinching pennies to seeing a chance to spend money and grow. Here are several quotes from BP's most recent conference call that highlight why management has changed its tone and what that means for investors.
Outlook for 2017 and beyond
A couple of years ago, CEO Bob Dudley was one of the first oil executives to talk about how he saw oil prices staying lower for longer. This was in contrast to several other executives and analysts that were foreseeing a rather rapid return to high oil and gas prices. It turned out that Dudley was right. Now, with 2017 in the company's sights, it appears that Dudley has some muted optimism for the coming year:
As we stand today, Brent oil prices have risen by around $10 per barrel since the OPEC deal was announced. We still expect oil demand growth to be strong this year at 1.3 million barrels per day, with modest growth in non-OPEC supply, which means the timing and extent of market rebalancing depends heavily on OPEC behavior.
The physical market has begun to tighten, with inventories falling a little faster than seasonal norms. However, OECD inventories at the end of 2016 were still close to 3 billion barrels, significantly higher than their recent historic average. We expect much of the historical inventory overhang to be eroded by the end of 2017 if OPEC and non-OPEC producers deliver on their promised production cuts. Any shortfall could delay this process, and thus still pose some downside risk to prices in the near term.
So while we remain optimistic about the market continuing to rebalance in 2017, we recognize that this could take some time. In short, the road to a more balanced position still has uncertainties.
This outlook is shared by many other executives. As OPEC production cuts start to erode the high levels of crude oil inventroy, we should see a decent uptick in oil prices in the coming year. It should be mentioned, though, that almost every company is planning for this kind of change in the coming year, and that in and of itself could change the trajectory of oil prices.
Turning to the Middle East
It wasn't that long ago that integrated majors were trying to shed themselves of production-sharing contracts or operating contracts in the Middle East. The thinking was with oil at $100 or more, why take such a small cut on these operations when there are bigger opportunities elsewhere? Much of that thinking has changed, though, as integrated majors are turning back to the Middle East for steady cash flow investments that have long shelf lives. BP recently signed such a deal in Abu Dhabi, and Dudley went out of his way multiple times to talk about it. For example:
More recently, we were awarded a 10% interest in Abu Dhabi's ADCO concession, which provides us with material long-term onshore oil reserves, low cost oil production and cash flows. These are resources that we already understand well, which will add resilience and production to our upstream portfolio out to 2055.
Again, BP isn't the only one doing this. French oil giant Total (NYSE:TOT) has made a big push into the Middle East lately with contracts in the same project as BP, as well as Qatar and Iran. Not only are these contracts more attractive because of the low-cost, long-shelf-life resources they provide, but the terms of these contracts are becoming much more attractive as companies like BP and Total can take larger working interest in the fields. Don't be surprised if these companies announce more big contract agreements with Middle Eastern partners in the future.
Winding down Deepwater Horizon
In late 2015, BP took a big step forward in resolving the Deepwater Horizon aftermath by agreeing to a $18.7 billion settlement with states in the U.S. Gulf Coast. With a clear payment plan in place and an exit on the horizon, CFO Brian Gilvary walked investors through the remaining payment schedule:
[W]e estimate Deepwater Horizon cash payments to be lower than last year, also in the range of $4.5 billion to $5.5 billion. As already noted, we expect the remaining business economic loss claims to be substantially paid this year. We therefore, expect the total Deepwater Horizon cash payments to fall sharply to around $2 billion in 2018, and to then step down to a little over $1 billion per annum from 2019 onwards.
It should be noted that the "onwards" in that statement refers to 10 to 15 years before all of this is settled. That is by no means an insignificant amount of cash, but it is certainly one that is manageable and shouldn't hamper the business too much in the coming decade or so.
Getting a little too optimistic?
Remember how Bob Dudley was one of the more pessimistic voices about oil prices just a couple years ago? Well, that position seems to be changing a bit. Here's how he sees the company balancing the cash coming in the door from operations versus outlays for capital spending and dividends:
[T]he group is moving steadily toward rebalancing our financial framework organically by the end of 2017 at around $60-per-barrel oil prices, which includes the operational impacts of our many recent portfolio announcements.
A $60 oil price target by the end of the fiscal year is by no means a pie-in-the-sky kind of projection. After all, the consensus seems to be that inventories will clear and prices will rise as we head into the second half of the year.
What is surprising about this, though, is that this $60-per-barrel balancing price is one of the highest among the integrated majors. Total, ExxonMobil, Chevron, and Royal Dutch Shell have all touted on recent conference calls that their largest development projects have a cash breakeven target of $40 per barrel, which should make their cash flow and spending levels break even closer to $50 a barrel.
When it comes to integrated majors, management teams have to make investment decisions based on where oil prices might be two, five, or even 10 years into the future. Having a slightly higher oil price breakeven target may open up some more new opportunities for growth, but they are more susceptible to being unprofitable ventures if prices crash. BP seems to be looking to be more ambitious than others today, so investors should watch how that bet plays out.
The sustainability of cost cuts
Also, one of the reasons why BP can be a little more optimistic about its possibilities is that the company has done an incredible job at lowering its cost base. Since 2014, annual operating costs have declined by more than $7 billion. Not all of it is completely attributable to BP, though. When asked how those cost savings broke down, here's what Dudley said:
Two-thirds of that is roughly from self-help, driving cost reduction simplification in. One-third of that is from deflation of costs.
That cost deflation point is an important one. Those are the costs associated with contracts for oil services such as drilling services, leasing rigs, etc. During the downturn, the cost for these services declined precipitously to the benefit of producers. As some oil services executives have mentioned on their own conference calls, though, those cost deflation gains may come to an end. Most of the large oil services companies made huge pricing concessions just to keep crews and assets working during this downturn. Today, though, they are much more focused on generating a return from those assets.
For BP, this could mean that all of that $7 billion in cost savings may not be 100% sustainable. As contract rates for equipment as services in the oil patch, it could lead to higher per-barrel operational costs and raise break-even prices. BP is already at the higher end of that spectrum, so this is an important development to watch through the rest of 2017.