Does BP Have A Winning Formula With Sustained Cash Flow?

Nov.22.13 | About: BP p.l.c. (BP)

According to the EIA, energy consumption is expected to rise from 524 quadrillion British thermal units, or btu, in 2010 to around 630 quadrillion btu by 2020. This increase in energy demand will be addressed by the development of projects around the world. In order to cater the rising demand, BP plc. (BP) was able to increase its worldwide hydrocarbon production, excluding Russia, by 3.4% year over year in the third quarter of this year. With more projects coming into operation, BP will be able to increase production of oil and natural gas in the coming quarters.

BP's Chirag oil project, or COP, is on course to start operation by the end of this year with the installation of a new offshore platform. The COP project is located in the Azeri-Chirag-Guneshli, or ACG, oilfield, which lies 120 kilometers, or km, from the coast of Azerbaijan and is expected to contain around 5.4 billion barrels of recoverable oil. BP has a stake of around 35.83% in the project. The offshore platform will be used to connect to the existing oil producing infrastructure in the field and will be used for drilling wells for increasing oil recovery from the reserves. The COP is expected to recover around 360 million barrels of oil during the life of the project. The project has a planned development cost of $6 billion, out of which it has spent $4 billion to bring the project into operation. The project will use the balance $2 billion for drilling development wells during the life of the project.

In addition to the COP, BP will also increase the production of natural gas from the North West Shelf Project in which it has 16.67% stake. The North West Shelf project commenced operation in October of this year after the completion of its redevelopment. This project will extract around 5 trillion cubic feet, or tcf, from the North Ranking and Perseus fields. This project involved the construction and installation of a new platform named North Rankin B. In addition to this, the project refurbished the existing platform, North Rankin A. The platform North Rankin A produces from 22 wells in the North Rankin fields and seven wells from the Perseus field. The total cost of the project has been around $4.71 billion, and this investment is expected to enhance the life of both fields until 2040.

Exxon Mobil (XOM), a major competitor of BP, is also focusing on production of oil and natural gas from its Kipper-Tuna-Turrum project. This project is located in offshore Victoria, Australia and started production in November this year. The project will extract natural gas and oil from three fields: Kipper, Turrum, and Tuna, and it is expected to have a life of more than 40 years. The Turrum field is expected to have a total reserve of 110 million barrels of oil and 1 tcf of gas, while the Kipper field is expected to have a total reserve of around 620 billion cubic feet, or bcf, of natural gas and 30 million barrels of condensate. The Kipper field will begin operation by 2016. The Tuna field has already begun production and is being developed to produce additional gas and liquids.

Another company focusing on increasing production of natural gas is Chevron (CVX). According to Chevron, the demand for natural gas is expected to grow by 40% through 2025. This will lead the company to increase its natural gas production from its various regions of operation. It is planning to meet these demands from major projects like those located in Gorgon, Wheatstone, and Angola. Chevron has a capacity to supply more than 20 million tons per annum, or mtpa, of natural gas. The company is also focusing on increasing production from the North American shale plays. In October this year, the company completed 12 wells for exploration drilling in the Duvernay shale formation located in Canada. Chevron plans to bring two rigs into operation for drilling and well completion.

Will the increasing cash flow trend continue?

The table shows BP's operating cash flow is increasing over the years.

Quarters of 2013

March 2013

June 2013

September 2013

Cash flow from operations ($ billion)

2.56

3.53

4.03

Cash flow from investments ($ billion)

4.93

-(2.01)

(3.62)

EBITDA ($ billion)

6.68

4.82

5.41

Click to enlarge

Source: Market Watch

As shown in the table, the operating cash flow is going to increase as the production of oil and natural gas is expected to increase in the coming quarters from the projects that are coming into operation. In addition, the Whiting refinery ramp up contributed a major increase in cash flow. The Whiting refinery is expected to reach full capacity production by the end of the first quarter of next year. The refinery has an upgraded capacity of processing around 405,000 barrels per day, or bpd, of crude oil. Out of the total crude the refinery will process, around 80% of it will be Canadian crude. This proportion of Canadian crude oil is going to increase the company's operating margin because of the price discount of Canadian crude oil compared to the WTI price. The Canadian crude oil price is around $30 per barrel less than the WTI crude price, resulting in lower input costs for the refinery. I believe the lower input cost will increase the EBITDA as well as increase the cash flow from operations for the company.

In addition to the increase in operating cash flow, BP is also increasing the cash from investments. It is achieving this through the divestment of assets, which include both upstream and downstream assets. As per the company's recent announcements, it will divest assets valued at around $10 billion. The proceeds from these asset sales will be used for share buybacks and dividend payments to its investors. In addition to the distribution of cash flow to investors, these divestments will help the company streamline its operations and generate returns on its capital investments. The company plans to invest around $24 billion- $25 billion next year.

The expected increase in BP's cash flow coupled with the company's intention to distribute cash flow to its investors in the coming quarters will result in an attractive dividend yield when compared to its competitors. The following chart shows BP's dividend yield compared to major oil integrated companies like Exxon Mobil and Royal Dutch Shell.

Click to enlarge

RDS.A Dividend Yield (TTM) data by YCharts

Cash in

BP is increasing production of both oil and natural gas from various projects that will help the company increase its revenue. In addition to oil production, starting up the Whiting project is going to enable the company to increase its operating margin over the coming quarters. The increase in production and the better operating margin will allow BP to generate healthy cash flows. In addition to the generation of cash flow from operations, the company is divesting its assets to streamline its operation, which I expect will enable the company to better utilize its capital. The summation of all these factors indicates that the company's cash flow will grow stronger over the coming quarters and will provide sustainable dividends. Currently the company is trading at an Enterprise Value/EBITDA, or EV/EBITDA, of 5.67, which I believe is going to decrease as the company's operating margin improves over the quarters. Thus, the company's attractive valuation and strong cash flow generation capabilities make it a compelling investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.