When I covered BP (NYSE: BP) earlier in the year I made the point that it was the oil major you’d probably have wagered was most at risk of a dividend cut, especially in the early days of the oil price slump. Taking into account its cashflow, net debt position and the ongoing liabilities relating to the 2010 Gulf of Mexico oil spill, I’d say that was probably a fair assumption back in the 2015-2016 period.
Fortunately the company seems to be doing a lot better these days – a statement that becomes readily apparent when you look at how much its cashflow has improved over the last twelve months. For instance, over the first three quarters of 2016 the company managed to generate $13.1 billion in underlying cash from its oil & gas operations while spending a total of approximately $16 billion on capital expenditure and cash dividends for shareholders. In other words we were looking at a fairly notable cashflow deficit, and that’s before you include several billion dollars worth of payments relating to the aforementioned Gulf of Mexico oil spill.
This year the company looks like it will manage to completely reverse the situation. During the first nine months of the year BP managed to generate $17.9 billion in underlying cash from operations, or an increase of around 37% compared to 2016, while spending approximately $16.5 billion on capital expenditure and shareholder dividends. Add those number together and it looks like the company has finally reached – and actually exceeded – the coveted ‘breakeven’ status in terms of cashflow.
(Source: BP Q3 2017 Results Presentation)
By way of explanation for those improved cash flow figures there appears to be three reasons in particular. Firstly, energy prices have improved notably since 2016. During the third quarter of 2017, for example, the price of a barrel of Brent crude averaged $52 – up from $46 during the equivalent period last year. Secondly, BP have managed to couple that oil price rise with a timely increase in underlying production. Excluding its 20% stake in Russian oil giant Rosneft, third quarter reported production was approximately 2.5 million barrels per day – up 16% on the same period last year. Total production came to 3.6 million barrels of oil equivalent per day in the third quarter of 2017, with the company expected to build on that in the final quarter. Finally, the downstream segment (i.e. refining, chemicals, retail and so on) posted a big jump in profits with respect to both the previous quarter and the equivalent period in 2016.
That said there are a couple of points worth noting here. Firstly, eagle-eyed readers will notice that I deliberately used the word ‘underlying’ when referring to cash generation. If you look up BP’s reported cashflow figure over the first nine months of 2017 you’ll find that it was actually around $13 billion and not $17.9 billion, the difference due to ongoing payments relating to the Gulf of Mexico oil spill. The good news that those payments are due to taper off sharply going forward, so we can probably expect a timely boost to reported cashflow which will better match our underlying figures.
Secondly, BP’s balance sheet situation is still worth monitoring. Despite posting strong cash flow figures net debt actually rose to $39.8 billion in the third quarter, up from $32.4 billion a year ago. As it stands the company still maintains a net debt to capital target of between 20%-30% – presumably the acceptable range in which funding the dividend retains priority. Investors might want to keep an eye on that given we’re currently near the upper bound, though the aforementioned improved cashflow situation now puts things on a more sustainable trajectory.
As we head into 2018 things look like they will improve further still (assuming oil prices remain roughly where they are now of course). Now as it stands the company is still forecasting an annual capital expenditure budget of between $15-$17 billion for next year. In terms of cash outflow the total annual dividend bill will add an extra $7 billion or so to that number. As for cash inflow, well, we can probably realistically expect a figure north of $23 billion for the year as a whole from BP’s oil & gas operations; the main drivers being $3 billion less in Gulf of Mexico payments plus a continued reduction in BP’s breakeven price per-barrel.
In terms of the latter the company expects that figure to be around $49 per barrel in 2018, roughly the same as it was in 3Q 2017, and by the start of the next decade management are guiding for it to fall to anywhere between $35-$40 per barrel. Chuck in cash from divestments, plus a bit of help from oil prices, and we might just start to see some elusive surplus free cash going forward – a big turnaround on where things were just twelve months ago.