BP (BP.) reported third-quarter results which were very strong given the weak commodity backdrop. However, although ongoing cost reduction efforts will provide some relief in the coming quarters, headwinds are looming that are sure to more than offset for some time. Key among these is the company's strong downstream results, where adjusted profits have been $6.3 billion year-to-date, roughly double last year's levels, and good for 75% of the company's reported 2015 income.
BP cannot pay its current dividend if oil remains at $50 forever
This show of strength is largely as a result of refining margins surging in Europe and on the U.S. West Coast during 2015. Neither of these markets can structurally sustain this, however, so while this has a been a very welcome offset to low crude prices, it is far from sustainable. Indeed, thus far in the fourth quarter, refining margins in these geographies are down at least 40%.
While BP's downstream is much more than U.S. and European refining, reality is looming, and profits in this segment are likely to be much lower in the coming quarters. There is one silver lining: while investors are right to have some concern about BP's ability to pay its dividend at lower oil prices, the company is actually in better financial shape than its European peers – that is, Shell and Total – given it had been forced to be very conservative in terms of capital expenditure commitments the last few years because of Macondo.
Further, the very attractive settlement terms BP agreed to with the U.S. government spreads the pain of oil spill-related payments over 20 years. The company is thus in better shape to weather the oil market downturn than investors are giving it credit for. To be sure, the company cannot pay its current dividend if oil remains at $50 forever, but it can for at least a couple years. And if oil recovers to $65-$75 as we expect, the company's dividend begins to look much safer, albeit with a continued noncash scrip program remaining in place.
