BP needs more than profit recovery to refuel shares

For a company whose profits have tripled year-on-year, BP shares are remarkably contained, up no more than 2% for most of Tuesday. A partial explanation is that after five years of some of the most ruthless cost and efficiency measures seen across the oil and gas industry, Britain’s second largest oil major has been begun bulking up again—on debt.  As well, whilst profits soared to $1.51bn in the first quarter, sailing past expectations just north of $1.25bn, BP’s 10.8% quarterly net debt rise to $38.6bn—up 25% over a year—looks set to pace the average for oil majors this quarter.

Some of the debt jump represents lingering Gulf of Mexico expenses. Most of the borrowing though has been earmarked for acquisitions and for ramping up production projects. In fact, the group plans to start the most projects it has ever launched in a single year, putting it on track to hike production by another 800,000 barrels per day within three years. That’s about a third higher than current daily output, including Rosneft. Gearing is within plan, but at 28%, the group is virtually at its self-imposed limit of 30% and at the upper end of its 20%-30% discipline range, even if leverage (net debt over core earnings) is reassuringly under the Big Oil average.

To be sure, a weaker headline profit performance than Exxon, BP, Total would have been most unwelcome, so BP’s threefold leap is a relief. But there’s also no getting away from Q1’s ultra-easy, rock-bottom comparable performance from Q1 2016, when profits had plunged 80%. Since then BP shares, like those of its rivals, rallied to a peak early this year, before slipping. The British group’s stock was up as much as 40% on the year at one point in 2016, but, again, like Exxon, Shell, ConocoPhillips and others it is underwater in 2017. In fact, shares of BP and Anglo-Dutch rival Shell join Norway’s Statoil as worst performers of the pack year to date, down 11%-12%, tracking a 10% fall in the North Sea’s Brent crude oil benchmark.

The Brent forward curve, which reflects price expectations, charts a similarly sober outlook, suggesting optimism about a straightforward rise to $60/barrel seen during last year’s recovery rally, has now faded. That underscores concerns that the floor in prices OPEC supply cuts were meant to create has been permanently softened by a flood of U.S. shale oil, as producers there grab market share.

The extra leeway in terms of cash generation from the group’s revving up oil and gas output is therefore BP’s primary means of defence right now, particularly as Deepwater spill losses tail off (to $161m in Q1 from closer to $1bn last year). Gulf-related expenses are widely expected moderate sharply again next year. That ought to mean more cash for projects which can increase production even further.  Naturally, such calculations will have to be revisited should oil’s drift lower accelerate.

From a technical perspective, the ambivalent oil price outlook combined with the group’s attempts to normalise financial risks, are well represented in BP’s price chart.

• The weekly view illustrates that BP shares remain well within the range it fell into two days after last June’s Brexit vote. Whatever the fundamental reason for BP’s the failure to recoup, 519.85p, 61.8% of the fall and proven resistance, and a more recent limit around 486p, remain the first hurdles the price must surpass
• The wider backdrop of course, is that the stock remains within orbit of the Macondo oil spill collapse—call the range 660p-300p
• The shares did breach their 461p threshold in January. But since then they have corrected all the way back to and below recent support near 460p.
• They closed on Tuesday within pence of their 200-week average. Should the stock lose pace with that closely watched weekly trend, investor caution would surely be turned up a notch
• On the other hand, the descending trend line all the way from mid-January 2010 to date was respected from the downside right up to the October 2016-January 2017 attempted breakout
• There are signs that price is remaining orderly on the topside of the line too, which is a small positive for bulls

DAILY CHART: BP PLC

Thomson Reuters and City Index