It seems BP (BP 2.35%) can't catch a break. Just when it was starting to put the Deepwater Horizon costs behind it, tensions between Russia and the West have put a big dent in its large holdings in Russian oil giant Rosneft. On top of that, falling oil prices are starting to take a bite out of earnings.
So, with so many questions surrounding the company and its future, here are several points BP's management wants you to know about the company and its path forward.
Taking a conservative approach
With the spectre of paying for the Deepwater Horizon looming over the company, and a realization that it was pursuing a lot of production for production's sake, the company drastically changed its project screening to ensure projects would be profitable at $80, which, at the time, looked pretty conservative. Today, though, $80 a barrel looks pretty optimistic, so CEO Bob Dudley explained that those same projects are now being tested for a $60 environment:
Over the last three to four years, we have been sanctioning upstream projects at $80 per barrel, while testing projects for resilience at $60 per barrel. Of course, in the current volatile times, we will look closely at each investment decision, taking account of current price levels, our ability to leverage deflation and our long-term outlook for the environment.
It's certainly reassuring that the company is taking such an aggressive approach to its costs, the question remains how many of those projects are going to be able to pass such a tight budgetary hurdle.
Turning U.S. operations into its own independent producer
A major announcement last year was that BP plans to spin off its Lower 48 exploration and production unit into a self-controlled entity within the greater BP company. To some, this might seem like a confusing move, so Upstream Chief Lamar McKay was quick to clarify the logic behind that decision as well as the expected outcome:
The rationale was that a new operating model was needed to improve performance in this business against its direct competitors, the U.S. independent.
We expect faster decision-making, more innovation and shorter cycle times through the value chain and expect that significant capital and cost efficiencies will follow.
Our plans, which include reporting separate financials, are on track. We are already seeing positive results from the more streamlined organization. We have had a workforce reduction of 900 employees and contractors and have seen cash cost fall by around 25% between 2012 in 2014.
Shale drilling in the U.S. is an extremely fast-paced market compared to many other oil markets around the world. Wells can see production decline by 50%-70% in the first year alone, which means capital expenditure decisions need to be made much faster than for many of the longer-tail projects that integrated companies have been used to doing for so many years.
Separating the Lower 48 business and giving it full discretion over its spending should help the company be more nimble, which should help it be more competitive with its faster-moving peers that operate almost exclusively in the U.S. shale game.
Big asset turnarounds have affected returns, but that's not necessarily a bad thing
One thing some investors might notice is that even though BP generated lots of cash from operations this year, returns on capital employed have not exactly been climbing. According to CEO Bob Dudley, this is actually by design:
[T]he average return on capital employed of the roughly $35 billion of Upstream assets that were sold had a return on capital of about 50% to 55%. Now, that is a huge return on very mature highly depreciated assets, so that by definition has brought our return on capital employed of the group down and I would expect it to continue to rise here up and down a little bit with the oil price cycles, but we are definitely high grading the portfolio going forward.
Return on capital employed is a measure of profitability based on how much that asset is worth on the balance sheet. This means many of its older assets that have depreciated over several years have very high return on capital. However, many of these assets needed to be sold to cover the costs of the Deepwater Horizon spill as well as rebalance its production portfolio, which naturally reduces returns on capital employed.
As newer assets start producing and their value can be depreciated, returns should tick back upwards.
Banking on deflation to cut costs
While there is not a specific quote to point to here, the term "deflation" came up an awful lot as a way to see costs come down. What management means by this is that it foresees many of its costs coming down as it renegotiates contracts with many of its service providers. In 2015 alone, the company has more than 1,250 contracts coming up for renewal. When they do, chances are, BP will be able to negotiate more favorable rates for these services that will help lower its cost structure to cover some of the anticipated losses in revenue from low oil prices.
Opportunistic purchases on the horizon?
Quite possibly the most surprising thing from this most recent conference call is that there was very little talk about future growth and taking advantage of a distressed market to make a few acquisitions. On the surface, it would appear that BP is in pretty good financial standing to make a decent-sized move. It has several extra billion dollars sitting on the balance sheet that aren't needed to meet working capital obligations, and a net debt to capital ratio of around 15%.
Based on the management's statements, though, this doesn't really appear to be on the radar screen as much as completing close to another $5 billion in asset disposals. Part of this is likely spurring from the final verdict for the Deepwater Horizon case, but with many of its peers mentioning that it might be time to go shopping, it seems a bit off that BP doesn't appear to be pursuing acquisition opportunities at this time.
What a Fool believes
You have to tip the cap at least a little to BP's management for massive cuts and cost savings over the past few years. Stressing new projects at $80 when oil prices were holding at $110 for so long might make the transition to an even lower price environment that much easier for the company long term.
That being said, less than $60 oil is going to take its toll on BP's earnings, and the persistent cost-cutting and asset sales might make some investors wonder where the long-term growth will come from to support that lucrative dividend payment. These two things are likely to weigh on the minds of BP investors, and management will want to address them.
