BP: Trouble Ahead

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

Summary

Former GE Chairman Jack Welch said: "Face reality as it is, not as it was or as you wish it to be".

BP plans to expand oil production indefinitely based on oil price of $50/barrel.

Q2 dividend maintained, but dividend only sustainable if oil price is in the range $50-55/bbl in 2017.

Projection of oil price hard to understand.

Former GE Chairman Jack Welch is well known for his pithy sayings. On reviewing BP's (NYSE:BP) Q2 earnings slide deck the saying that I thought apposite is: "Face reality as it is, not as it was or as you wish it to be".

There is a lot of material in the presentation that is worthy of reflection. BP is convincing about its strengths concerning operational issues, but when it comes to market conditions and consideration of the context for the oil (and gas) industry, Jack Welch's saying is relevant.

Here are a few key points.

Where the oil price is headed

The BP report presents the historical curve for Brent Crude (see below), but then a flat upwards projection is made with what looks like ~$52/bbl by the end of 2017. While I agree that it is a brave person who can project where the oil price is headed, a projection upwards given the current trajectory is brave.

The text that goes with the Brent Crude graph is as follows:

"As we expected, growth in global oil demand remains strong and we have seen some slowing of global supply growth stemming from supply disruptions, partially offset by the continued increase in Iranian production. In the United States, production continues to decline and we anticipate a further drop in the third quarter, but with producers slowly adding back rigs, production should stabilise by year-end.

While some of the factors that have recently supported oil prices may only be temporary, we see the overall fundamentals bringing the market into balance during the second half of this year. Over the last quarter we have seen oil prices strengthen in anticipation of this rebalancing - with some weakening primarily due to the strong dollar in the last week or so. The longer-term fundamentals for the industry remain robust….

My reading of the Brent Chart indicates that Brent crude price has been falling since early June, which means the fall for the "last week or so" indicated by BP is in fact around 6 weeks (and no change from downwards projection in sight).

BP also shows that OECD commercial inventories have been growing steadily since Q1 2015. Surely this is a problem?

I think there is a prima facie case for facing reality here. Reality does not indicate a gentle upwards move in the oil price curve.

Source: Nasdaq Crude Oil Brent

Growth in an era when the fossil fuel industry must decline?

It is clear that BP chooses to ignore the need to decarbonize the international economy (see Jack Welch again), and so they are planning to expand production, and are on the lookout for acquisitions.

Their projections include an additional 500,000 barrels of new production by end of 2017 and 800,000 barrels of new production by 2020. All of this additional production seems to be locked in. This is in an environment where the inventories are growing steadily. Who will buy the oil?

And lest one might think that reality will seep in around 2020, there is a clear commitment beyond 2020 for long-term growth, with 45 billion barrels of resources and 50 years of production at today's levels. Management makes a virtue of not needing more exploration to be able to grow production.

The basis for the expansion is $50/bbl for oil, but no attention is paid to whether there will be a market for ever expanding oil in a world that may have banned internal combustion engine fuelled cars.

I find it hard to comprehend this intention to keep growing production in a world that is moving to exit fossil fuels.

Medium-term financial frame

Sourcing and use of cash is stated as being at parity with an oil price of $50-55/bbl by 2017. It would help me (and I'm sure I'm not alone) to understand the business better if there was some indication of good times (i.e., what an oil price of say $60-65/bbl) and hard times (i.e., what an oil price of say $40-45/bbl) might do to the business. This would allow an investor to get a sense of what impact a positive or negative change in the oil price might have on the business.

While I don't claim to understand the intricacies of the payout for the Gulf of Mexico oil spill costs and provisions, I'm not sure that BP's certainty about the overall costs to be incurred is grounds for celebration. From the high level figures they give, it seems that less than half of the costs have been paid out of the Trust Fund ($20 billion) and that the additional costs (a further $23.4 billion after tax) will be paid as they arise. It seems that two pre-tax charges of $5.2 and $1.6 billion were paid out in Q2. This is no small amount, which might have some impact on considerations about the dividend. Perhaps I have misunderstood this, as on another slide the first half Gulf of Mexico oil spill payments is described as $2.7 billion.

Dividend

Notwithstanding the difficult times, the Q2 dividend is maintained at 10 cents per ordinary share. However, the basis for ongoing dividend payments made in the presentation is cause for concern.

To quote the report: "We have strong momentum in resetting our organic sources and uses of cash to balance in a $50-55 per barrel oil price range, supporting our ongoing commitment to sustaining the dividend." This might give some investors reason to reflect on the certainty of BP maintaining its dividend.

Conclusion

When one considers investment in a company, one must have confidence in the management and its ability to make sense of the current situation and have a plan for the future.

There is too much in recent reporting that suggests to me that, uncertain times notwithstanding, management of BP is not facing up to reality. This makes it hard to have confidence that the BP enterprise will be safely steered through the coming rough water. I see warning signs for maintenance of the dividend and that is just the start of the problems.

Disclosure: I/we 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.