BP In Limbo As Brent Stumbles

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About: BP p.l.c. (BP)
by: Callum Turcan
Summary

An overview of BP's cash flow, earnings, and growth prospects.

Limited flexibility on spend, expect cash flow shortfall to stay.

BP in awkward spot of posting profits but losing cash.

Wave of upstream projects will help change that, but that will only go so far.

British energy giant BP plc (NYSE:BP) saw a material improvement in its financials during the first quarter of this year. Still plenty of work to do, but let's look at what's working in BP's favor.

Financials

In Q1, BP generated $1.5 billion in underlying replacement cost profit and $4.4 billion in net cash flow ($2.1 billion in operating cash flow plus $2.3 billion for pre-tax Gulf of Mexico liability payments). During the same quarter last year, that figure was just $500 million for underlying profit and net cash flow of $3 billion ($1.9 billion in operating cash flow plus $1.1 billion in pre-tax GoM payments).

Driving the turnaround was its upstream unit, albeit one that set a low bar during the downturn. BP posted $1.4 billion in income from its upstream unit versus a $700 million loss a year earlier, while its downstream profit slipped by $100 million to $1.7 billion.

Stability from its downstream (refineries and petrochemicals) division has helped out immensely, but ultimately upstream operations are what drives big oil.

BP aims to spend around $15-17 billion on capital expenditures this year, $3.5 billion of which was spent in Q1. GoM liability payments will come in around $5 billion, and its annual dividend payments are also around $5 billion.

$25 billion in 2017 cash flow outlays outpaces its $18 billion in annualized cash flow based off of Q1 results, which is why management aims to raise $5 billion this year through asset sales.

Some key things to keep in mind. Next year, GoM payments will drop down to $2 billion and from 2019 onwards, BP's annual payments will move lower still to $1 billion. This will coincide with BP's annual divestment program going back to "normal" levels of $2-3 billion.

BP will spend more than it brings in this year short of a major rally in oil prices. The firm doesn't have the financial flexibility to scale down its spending habits. It won't cut its dividend, it has to pay its legal liabilities, and capex is needed to bring its major projects under construction online. On top of all of this, BP makes the occasional purchase that isn't include in its organic capex guidance.

So BP is in the situation where it is generating a profit but still losing cash and seeing its balance sheet weaken. Divestments will help but BP needs $60 Brent to reach cash flow neutrality according to its guidance.

Upstream

BP pumped out 3.5 million BOE/d net in Q1 2017, 1.1 million BOE/d from its stake in Rosneft (OTCPK:RNFTF) and 2.4 million BOE/d from its global upstream operations. That was 5% higher than its output in the same quarter last year.

Management hopes to add 1 million BOE/d to BP's upstream asset base by 2021 (the 800,000 BOE/d figure is for 2020). The idea is that these new projects will sport favorable economics due to price deflation, better operational execution, efficiency gains, and due to the conventional nature of the developments.

One number BP brought up was that "the portfolio under construction is ahead of schedule and around 15% under budget." That would be great but this shouldn't be taken at face value, it is far too vague. A nice comment, but there is far too much uncertainty around some of these truly massive projects (like the Shah Deniz project in the Caspian Sea and associated pipeline build-outs) to assume this has a good chance of holding true.

Now to be fair, there are some bright spots management must have had in mind when writing up that sentence. Production from the West Nile Delta project in offshore Egypt officially started up in March eight months ahead of schedule and under budget. The Taurus and Libra fields will primarily produce dry gas with some condensate output, most if not all of which will be sold to Egyptian consumers. This speaks very favorably for BP's future Egyptian growth projects, of which there are several of.

This comes on the heels of the successful start-up of its compression project in Trinidad & Tobago earlier this year, which is also heavily focused on natural gas, and the recently operational Quad 204 oil-weighted project in the UK's North Sea.

BP also has the Zohr project in Egypt, the Persephone development in Australia, the Juniper venture in Trinidad & Tobago, and the first phase of the massive Khazzan development in Oman set to come online later this year.

Combined, BP's upstream production should receive a major jolt heading into 2018 as 500,000 BOE/d in net production capacity is added to its asset base. This is assuming the firm continues to deliver on the operational execution front.

Downstream and retail

As I said at the beginning of this article, BP's downstream division has been the bedrock of stability during these very trying times. Seasonal trends will work in BP's favor in Q2 and Q3, but there is more to look forward to than that.

Back in 2014, BP set off to improvement operations at its PTA plant in South Carolina. Originally those upgrades were supposed to be completed by mid-2016, but it wasn't until Q1 2017 that this project was finished. While not a huge investment (around $100 million) these upgrades will help reduce BP's operating costs, enhancing margins from one of its most stable businesses.

Those who follow the energy sector are probably aware of Mexico opening up its oil & gas sector to private firms a few years ago. One big growth region is on the retail front, where margins are very stable (not awe-inspiring but reasonable).

BP opened its first retail site in Q1, the first in what management hopes will be a 1,500 store build-out over the next five years. Not a needle mover yet but a great source of growth assuming Mexico continues on its reform and market modernization path.

Final thoughts

Like all major oil firms, BP is showing signs of serious improvement. Also like most major oil firms, BP's spending levels are based on a optimistic view of the market. It appears BP sees $60 Brent being achievable by the end of 2017 so cash flow neutrality is feasible heading into 2018, but that might not be the case even with OPEC action.

This is why the start-up of BP's major developments, particularly on the upstream front, are so important. BP will gain greater financially flexibly completing those developments but I'm assuming most of that capex rolling off will be reinvested into other projects, making these start-ups primarily about additional cash flow streams.

With energy prices not cooperating, BP is leaning heavily on solid operational execution. Investors looking to read more about BP plc should check out recent bullish developments out of Trinidad & Tobago.

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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.