I have to imagine that BP (NYSE:BP) CEO Bob Dudley has to be slightly relieved. This will be the first quarterly earnings release under his tenure as chief executive where the company doesn't have the Deepwater Horizon's specter of uncertainty hovering over it. Unfortunately, management can't take a victory lap because now it has to deal with the continued weakness in oil and gas prices.
With the company's future related to anything Deepwater Horizon much more certain, here are three questions that BP's investors should look to have answered this quarter.
Can downstream earnings continue to prop up weak upstream profits?
Last quarter was the shining example as to why companies like BP and its peers remain vertically integrated across the entire value chain of oil and gas. Even though upstream earnings declined to about $600 million a ghastly 86% in the first quarter compared to that time last year, its downstream segment was able to help bolster results. Last quarter's $2.2 billion from downstream operations was more than double the prior year's result. More importantly, the company was able to generate $1.8 billion in operational cash flow. Nowhere near the amount it needed to meet its capital expenditures, but it prevented a completely disastrous quarter.
This quarter, investors should see if BP was able to achieve similar results from its downstream segment. We saw a slight increase in the average price per barrel compared to the first quarter, and investors should look to see if the company was able to maintain strong margins from this downstream segment to cover up the glaring weakness in its production numbers.
Can it continue to cut costs without compromising future projects?
With prices for oil and gas where they are, the only thing that BP can do to maintain some level of profitability from the production side of the business is to cut costs. This past quarter, the company announced some major cost-cutting efforts ranging from cutting overall head count to cancelling contracts with drill rigs in the Gulf of Mexico as well as postponing drilling activity at the Magnus platform in the North Sea.
Scaling back when times are rough is something that you have to do in this business, especially when operational cash flow starts to wither on the vine. However, the fear with cutting back too much is that it could come back to haunt the company a few years from now when its development portfolio isn't as robust as it needs to be. According to the company's strategic plan for production, both the North Sea and the Gulf of Mexico will be major components of its production and cash generation.
If BP is forced to cut back spending in these two regions significantly, it could make those 2020 goals less attainable. So investors should look at whether there are any indications as to where BP plans to further cut back spending today to preserve cash.
What is the long-term payoff plan for the Deepwater Horizon?
Let's be clear: The effects of the Deepwater Horizon spill are not completely behind. It is the uncertainty of the situation that is largely behind them. As part of the settled deal between the federal government and the Gulf states, BP will pay a total of $18.7 billion over the next 15-18 years. So for at least the next decade and a half, BP will need to dish out an additional $1.04 billion-$1.28 billion each year to cover those costs. That is akin to more than doubling the company's interest expense annually.
To be fair, this is a manageable amount of money to dish out. But investors would be naive to think that this won't have a material impact on the company's cash flow. Also, there are questions as to how exactly it will cover those expenses over time. Will it pay them out exclusively from cash generated from operations each year? Or will it pay it down in larger lump sums through further asset sales over time? We all know how much it needs to pay, but investors will be put further to ease if management spells out exactly how it intends to pay those expenses.
What a Fool believes
Anyone looking for a high-yielding investment is going to stare at BP's better-than-6% yield very, very hard. Management has said on multiple occasions that protecting the dividend payment is its No. 1 priority, but the forces of low oil prices are going to really put management's resolve to the test over the next couple of quarters. For those who are wondering whether BP can maintain that sort of payout, answers to the three questions above should help to put that possibility into perspective.