If we were to compare BP's (NYSE:BP) recent conference call to a boxing match, then CEO Bob Dudley came out swinging. Many investors and analysts were starting to question the company's ability to extract profits from its production in a low-price environment and its ability to grow while cutting back capital spending. So management really went out of its way to explain its plans for both the short and the long term following its most recent earnings release. These five quotes below give a pretty good idea of what Dudley wanted to get across to the company's shareholders.
When we say "lower for longer," we really mean it
We have seen energy executives across the industry say that they don't expect the oil market to significantly recover until late 2016 and possibly 2017. According to Dudley, that may even be an optimistic outlook. He has been preparing his company for the possibility that oil prices may not recover significantly until the next decade:
Earlier this year, the forward price strip for Brent oil pointed to prices of almost $80 before the end of the decade. Some even speculated that prices might rebound quickly to previous levels. The market is now pricing in a much flatter trend for the oil price to 2020 and beyond. This is driven mainly by the expectation that supply will continue to be strong and there is a more cautious outlook on Chinese demand growth. This reinforces the need for a business model that can withstand a longer period of lower oil prices, and we've been resolved to that for some time.
Getting back to profitability
While $80 per barrel would be a dream right now, that doesn't really help projects that are coming online today. Fortunately for BP, several of the projects it has coming online in the coming months should be profitable at much lower prices.
In the upstream, we are further insulated by around one-third of our production coming through production-sharing agreements as well as by having a series of high-quality gas projects in countries that are short of domestic gas. Around 80% of our potential investments are currently expected to breakeven below a $60 Brent oil price. And we would expect this breakeven to move lower as we further take advantage of deflation.
BP is in the middle of the pack among its big oil peers right now when it comes to maintaining profitability from the production side of the business. It hasn't been able to weather the storm like Total (NYSE:TOT) has in recent quarters, but at least its upstream segment has remained profitable.
|Company||Upstream Earnings (Q3 2015)||Upstream Profits (Q3 2014)||Change|
|Royal Dutch Shell (NYSE: RDS-A) (NYSE:RDS.B)||($425)||$4,343||(110%)|
If these new projects pan out like Dudley claims, then perhaps BP can improve its upstream profitability.
Greater opportunities further down the pipe
Another thing that Mr. Dudley wanted to make clear was that the company was going to be much more scrupulous when to came to making final investment decisions for new projects.
The ability to exercise quality through choice and to flex our capital allocation means that the new project and drilling spend will only get sanctioned when it is right. This means we aim to achieve a rate of return on our new greenfield major projects in the mid-teens at an oil price now of around $60. And our drilling programs around existing assets and follow-on projects will only progress if they return over 20% on the same basis.
This is a good sign, because up until recently BP was assessing its projects based on an oil price of $80 Brent and a "stress test" of $60, which put them on the high range for price assumptions compared to several of its peers.
|Company||Price Assumption for New Projects|
|BP||$60 (was $80)|
|Royal Dutch Shell||$70|
|Total||$60 (may move to $45 in 2016)|
We still have some strong production growth coming with lower spending ...
BP and many of its peers have been saying they plan to significantly cut capital spending over the next few years to adjust for current oil prices and the fact that many major projects have come to a close. That has some investors slightly concerned BP isn't planning to spend enough to grow production. To get out ahead of this, Dudley went into detail about several of its major projects and how much that will add to the production portfolio of the company:
By 2020, over 500,000 barrels of oil equivalent per day of new project production is anticipated to come from the delivery of seven key projects, which are progressing well. These include the substantial long-life gas profiles of the Oman Khazzan project, in Trinidad, the West Nile Delta, and the Shah Deniz Phase 2 projects that will grow and maintain production in these new and existing integrated gas value chains. Some of our post-2018 projects include exciting new discoveries made in the last 18 months, including Atoll in Egypt and Vorlich in the North Sea.
Clearly there are plenty of projects to work on in the coming years, but it depends largely on how BP can execute on those projects and bring them online within budget.
... and a very large resource base from which to draw
The other concern about lower spending is that the company may not do enough exploration work to replace its production with new reserves. While the company acknowledges that it may not replace all of its reserves, Dudley pointed out that BP has a pretty deep bench of potential resources to draw from before that becomes a huge concern.
Putting aside Russia for a moment, we have a hopper of 44 billion barrels of oil equivalent underpinning this growth, 11 billion barrels of which represent proved reserves from existing base assets and projects that have passed final investment decision. The progression of the remaining 33 billion barrels underpins our continued growth beyond 2020. Around 70% sits within our base assets, and these are being prioritized and optimized in our area development planning process, which seeks to progress the very best barrels. The remainder represents our major projects and resource appraise options that have not passed the final investment decision, and that continue to be matured and optimized to meet our investment criteria.
Investors should be willing to give BP and other integrated majors some slack when it comes to replacing reserves in the coming years. If it persists for several years, though, then it may be time to get concerned.