What a difference a year makes

Published on 01-03-2017 11:31:2501 March 2017

BP’s 2017 strategy presentation served to highlight what difference one year can make in the world of integrated oil and gas. Upstream FCF guidance provided in Baku (2016) of $7-8bn in 2020 has been increased to $13-14bn in 2021. Combined group, upstream plus downstream, FCF guidance for 2021 now totals $22-24bn pre-tax. This is a material step up in post capex cash generation with the excess available to address scrip dilution, distribute to shareholders, reduce gearing, or pursue growth – assuming guidance is achievable of course. An upstream FCF bridge is provided below showing that a significant proportion of the increase comes from a 5$/bbl increase in oil price planning assumption from 50$/bbl real to 55$/bbl real as well as recent acquisitions, most importantly the ADCO onshore concession.

Management guide at a 2021 oil balance point (post dividend) of 35-40$/bbl.
BP expect the organic oil price balance point (including dividend coverage) for the group to fall steadily through to 2021 from c.60$/bbl Brent today to 55$/bbl by year end 2017 and then down to $35-40/bbl by 2021.

Clearly BP will be a very different investment opportunity than it is today if it is able to deliver on its ambitious FCF target. Within BP’s sphere of influence, management need to ensure the upstream remains resilient to cost inflation headwinds, and deliver on post-FID projects in order to deliver on a 5% per annum production growth (an aggressive target). For unsanctioned greenfield projects BP is targeting a >15% (mid-teens) post-tax IRR at 60$/bbl and >20% for brownfield. If management are able to deliver on target returns and oil prices exceed 60$/bbl, upstream investments should help drive group ROACE beyond 10% beyond 2021. BP currently target >10% by 2021.

ROACE remains stubbornly low across the sector, and as for BP, $50bn of asset sales of high-return upstream assets combined with heavy capital investment on pre-FID projects in a high cost environment will remain a drag on ROACE out to 2021. Another risk to ROACE is the group’s increasing focus on gas. Lower48 returns are highly leveraged to Henry Hub (plus regional differentials) which has fallen to c.2.5$/mmbtu in recent weeks. In order to ensure Lower 48 returns remain competitive management will have continue to drive down drill times, well costs whilst driving up IP rates and EUR.

Cost inflation headwinds
BP reiterated the importance of disciplined capital and cost management in a rising oil price environment and the value of cultural changes and technology in ensuring structural and sustainable changes to the companies cost base. Buzzwords include digitization, streamlining, standardization and collaboration. Combined management believe that c.75% of cost reductions should be sustainable through-cycle. We will determine the success of structural changes and their impact on BP’s ability to drive up returns and FCF in the medium-term. In the short-term, 2017 will be a test of BP’s project execution capability with 7 major projects due on-stream (Juniper, Khazzan, Persephone, Quad 204, Trinidad onshore compression, West Nile Delta (Taurus/Libra), and Zohr).

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