BP (BP.) saw profits halve from $933 million from $1.8 billion a year ago in the three months to the end of September. The oil giant also reported a decline in third-quarter earnings as low oil prices continued to weigh on earnings.
Periods of prolonged low oil prices weaken returns on capital
The upstream segment – oil extraction and production – posted a loss of $224 million, compared with earnings of $823 million last year on lower realisations and a 5.9% decline in volumes, owing largely to maintenance and turnaround activity. Downstream earnings – oil refineries and marketing – continued to generate the bulk of earnings, as it has over the past two years, but its contribution fell to $1.4 billion during the quarter from $2.3 billion, as the fuels business suffered from narrowing margins and turnaround activity.
Rosneft profit fell to $120 million from $382 million last year, primarily due to lower oil prices and increased government take. Our view on BP, including our fair value estimate and moat rating, is unchanged, as the quarterly results were largely as expected and guidance items were left intact outside a slight reduction in 2016 capital expenditure.
BP remains on track to achieve its $7 billion cost-reduction target by 2017, with $6.1 billion in reductions achieved to date. The cost reduction, combined with slightly lower capital expenditure, should allow operating cash flow to cover capital spending and dividend, assuming that the price of oil settles at about $55 a barrel in 2017. By 2018, however, BP should be in a position to cover a full cash dividend at $55 a barrel.
BP's profits and cash flow are largely tied to hydrocarbon production and highly leveraged to movements in the price of oil. Periods of prolonged low oil prices weaken returns on capital, and new oil and gas projects would be unlikely to generate their projected economic results. BP employs huge amounts of capital in building out its production portfolio, and cost overruns and/or completion delays are continued sources of uncertainty. Greater reliance on highly technical projects is likely to increase these risks.