The collapse in the oil price in recent weeks has seen BP’s share price fall sharply, to levels last seen in the mid-1990s, and while it isn’t alone in the oil and gas sector in seeing massive declines, it remains particularly exposed to the US shale sector due to its acquisition of BHP Billiton’s shale assets in the Permian Basin in 2018 for $10.5bn.

BHP Billiton purchase proves costly

In hindsight this probably wasn’t the wisest decision, however even at the time there were many questioning the thinking behind it, even with oil prices above $60 a barrel, and at a time when BP had made such great strides to make itself a nimbler business in the aftermath of Deepwater Horizon. The thinking at the time was that the deal would prove to be self-financing, however this was always a touch optimistic given that oil prices were near their highest levels in four years and looking a little bit stretched. It was especially puzzling given that, even then, the overarching narrative was leaning towards renewables, and big sovereign wealth funds were pulling back from investing in oil and gas assets.

Since then oil prices have slowly made their way lower, and while cost-cutting and asset sales has helped BP cut its breakeven price down to below $50 a barrel, the costs of that acquisition became all too painfully clearer in April, when US crude prices plunged below $0 for the May contract, with current prices only a few dollars higher in the low to mid-teens.

BP share price opens lower on Q1 numbers

The BP share price is lower in early trading this morning, down around 2%, as we got to see some of the impact of the bloodbath in US and Brent crude prices, as well as the collapse in demand for downstream products in the wake of the Q1 numbers. The company booked losses attributable to shareholders of  $4.4bn for the quarter, mainly attributable to losses on inventory of $3.7bn.

In terms of underlying replacement-cost profit for Q1, BP eked out a profit of $791m, compared with a profit of $2.4bn a year ago. Net debt rose to $51.4bn, pushing gearing levels up to 36.2% from 31.1%, a worryingly high level at a time when oil prices, as well as gas prices, show few signs of moving higher.

Cost-cutting exercise

BP CEO Bernard Looney said that the company was looking to take a further $2.5bn worth of costs out of the business by the end of next year, and bring the breakeven price for crude oil down to $35 a barrel. This is still well above the levels currently, which means that even if he were to succeed, the company will still be burning through cash, albeit a little more slowly than currently. This collapse in demand and prices is all the more worrying in the context of BP’s commitment to become a net zero carbon business by 2050. Yesterday, BP confirmed its commitment to the sale of its Alaska business to Hilcorp for $5.6bn, a process which began in August last year, and is part of an overall divestment process which management hopes will return up to $15bn by mid-2021. This remains on track.

At the beginning of April, BP said it had liquidity of around $32bn, $10bn of which is a new revolving credit facility, and undrawn facilities as at the end of the quarter, and while the company said that disruption due to Covid-19 was limited in Q1, the outlook for Q2 is going to be much more difficult. In April BP also issued $7bn of new bonds.

The company also said it expected capex to be around $12bn, a reduction of 25%, below its previous full-year guidance, with $1bn reductions in both upstream and downstream operations. In terms of upstream operations, output dropped to 2,579m barrels equivalent a day, a 2.9% fall from a year ago, while lower demand for jet fuel, gasoline and other refining products has seen downstream results come in much lower than Q4, dropping from $1.4bn to $921m in underlying replacement cost profits.

Dividend remains but outlook difficult

In conclusion, BP has said the outlook for 2020 is expected to be difficult, due to Covid-19, alongside the current lack of demand, which means the pressure on the company’s finances is likely to remain pressing. Downstream in particular is expected to see material impacts in Q2, with the risk of more sustained consequences if the crisis continues. BP also said it expected to pay out another $1.2bn in respect of Deepwater Horizon in Q2.

For now, BP has decided to maintain the dividend of 10.5c a share, however if we continue to see gas and oil prices languish near their current levels, the pressure to make cuts on shareholder payouts is only likely to rise further. The company may well be able to paint a $791m replacement cost profit as a positive, but those inventory losses point to a clear danger of further pain in the coming months, unless demand picks up.

 

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