BP plc Will Fly When The Oil Price Recovers!

BP plc (LON: BP) has enjoyed a reversal in its troubled fortunes lately but it needs higher oil prices to really start motoring, says Harvey Jones

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Until 18 months ago, BP (LSE: BP) was largely the architect of its own misfortune. The Gulf of Mexico blow-out and controversial tie-up with Kremlin-controlled Rosneft both stemmed from its own actions. But there was nothing the oil giant could do about the plunging oil price, an event almost entirely beyond its control. BP is at the mercy of wider forces, which is never a good place to find yourself.

With oil collapsing to around $50 a barrel, BP’s profits were bound to collapse as well. Hence the 40% drop in Q3 profits to £1.8bn. BP isn’t completely helpless, there is plenty it can do to mitigate the damage, such as offloading assets, cutting jobs, slashing capex and dumping unprofitable oil projects. This kept investors happy and allowed it to hold the dividend unchanged at 10c a share.

Cash Flows

The money BP has raised from these activities was hardly insubstantial. Divestments have brought in $7.8bn so far this year, which should hit $10bn by the end of the year. This should bring in a further $3-5bn next year, with $2-3bn a year thereafter. The money will offset all volatility, fund remaining Deepwater compensation payments, and allow BP to keep its generous dividends flowing a while longer.

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BP has also cut forecast capex spend from around $25bn a year to “just” $19bn this year. Controllable cash costs are also down around $3bn. With an annual dividend bill of around $9bn, BP needs to raise all the cash it can to avoid a damaging cut to its payouts. Its downstream business is doing well, with Q3 pre-tax profits of $2.3bn, up from $1.5bn during the same period last year.

Dudley Do-Right

What BP really needs is a higher oil price. Chief executive Bob Dudley is bracing himself for oil at $60 a barrel until 2017. At time of writing it trades at $46.75, well below the required number. Dudley claims to have “reset BP for a sustained period of lower oil prices and the results are coming through well”, but has he set his sights low enough? Goldman Sachs is predicting further downside risk for oil prices next spring.

Should the oil price fall further, BP and Dudley could be hammered for this week’s optimism. Worse, today’s juicy 6.47% yield could ultimately come under pressure, as the dividend becomes unsustainable.

Shock In The Dark

The oil price could flip in an instant. A change in Saudi’s sky-high production policy, or even the hint of a change, could see it soar. If events get out of hand in Syria, again, the price could fly. A continuing drop in US rig count as shale industry margins wither could also hit supply. Demand is less likely to come to BP’s rescue, as deflation tightens its grip on the global economy, but a supply shock could quickly force prices upwards.

Dudley appeased the market this week and BP’s share price is now up 14% over the last month. If oil does hit $60 and beyond, its share price will fly. Buy now and you are effectively betting that the oil price will recover to $60 or higher. It could prove a lucrative bet, but remember, the oil price is beyond your control as well.

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Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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