The surge in oil prices after the attack of the Saudi oil infrastructure benefits pretty much all oil and gas producers. Higher oil prices will increase revenue and profits, and the British energy giant (BP – Get Report) is no exception.
But besides these obvious consequences of higher prices in a commodity business such as the oil and gas industry, BP will take advantage of the situation in three ways:
1. Better Conditions for Asset Sales
After the acquisition of the BHP assets last year, BP’s debt became elevated. At the end of last quarter, net debt reached $46.5 billion compared to $38.7 billion the year before. As a result, management committed to divestments to reduce the debt load. The goal was to reach $10 billion of asset sales through 2019 and 2020.
The company got closer to this objective with the sale of its Alaska business to Hilcorp announced last month for $5.6 billion. And with the previous transactions that generated $1.5 billion, management still has to proceed with about $3 billion worth of asset sales over the next 15 months.
Until last weekend, the challenge for BP consisted of negotiating fair prices in the context of a Brent price below $60 a barrel. And the perspective of lower oil prices because of the tensions between the U.S. and China didn’t help.
Thus, the timing of the surge in Brent prices above $66 a barrel is perfect for BP to complete its divestiture program and reduce its debt before the end of 2020. Higher sustainable oil prices are uncertain, but the shift in the market sentiment will certainly put BP in a better negotiating position.
2. Timing of Production From New Projects
The evolution of oil prices over the last several months seems to fit BP’s agenda in another way. During the last earnings call, management announced Q3 production would drop compared to Q2 because of maintenance activities. As Q3 is ending in two weeks, production should grow again, and this shift coincides with the increase in oil prices.
Besides, management is still planning to add 900,000 barrels a day of new production by 2021. In comparison, production reached 3.786 million barrels a day during the first half of the year. Experiencing a surge in oil prices when the company is bringing online big projects to support the new production is fortunate.
3. Comfortable Oil Hedges
During the last earnings call, management confirmed the company’s oil breakeven price would drop in the range of $45/bbl to $50/bbl by 2021, based on Brent prices. Also, the goal of generating $15 billion of free cash flow by 2021 assumes an average Brent oil price of $55 a barrel.
The Brent price now above US$66 a barrel provides a huge margin of safety. And the company has the opportunity to protect its cash flow at a much higher price than it needs to sustain its production and reach its objectives.
The company doesn’t disclose the details of its hedges. But I expect management to profit from higher hedges as the annexes of the financial statements show the company regularly hedges its oil production. For instance, at the end of last year, the fair value of crude oil derivatives was $1.6 billion.
Investors should look beyond the higher profits associated with higher oil prices to gauge BP’s upside potential. Given its specific situation, BP profits from the recent surge in oil prices in multiple ways.
Management is in a better position to complete its asset divestiture program at favorable conditions. And the expected increase in production coincides with higher oil prices. Besides, the company has the opportunity to hedge a part of its production at a higher price than it needs to reach its medium-term goals.