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BP's Lower 48 Operations Need $3 Henry Hub For 'Really Viable Business'

BP plc is becoming more competitive in the Lower 48 onshore following years of neglect, but natural gas prices under $3.00/Mcf Henry Hub put operations under more pressure, the company’s upstream chief said Tuesday.

The UK-based producer was the first of the U.S.-focused Big Oil companies to report third quarter results. BP CEO Bob Dudley led a marathon conference call that lasted more than two hours to lay out a strategy.

Plans are to balance organic cash flow with spending by 2017, while continuing dividend payments. However, if oil prices are lower than $60/bbl, "I have no doubt industry will continue to respond," Dudley said.

Every item in the portfolio is being scrutinized. If it doesn’t meet the price threshold, chances are lower that BP would move forward on development. And achieving growth in the Lower 48 with gas prices below $3.00 could be a stretch, upstream chief Lamar McKay said during the call.

Lower 48 operations should be profitable "at basically about $3.00/Mcf," he said. "We're quite a bit below it as of today...and we get free cash flow positive around $3.00. Now that's not the easiest thing in the world, but that's what we've given the team to shoot for..."

The Lower 48 operations team has made "massive progress on cost, where I think we're basically competitive in each basin that we operate, and they are making fast progress on capital..."

At a current gas price of about $2.10/Mcf, achieving set goals "is not going to be great, but the business, I guess, will adjust to that over time,” McKay said. “But realistically, we're thinking somewhere closer to $3.00 to have a really viable business there and have a chance to develop the assets we have."

As the portfolio stands now, 90% of BP's projects in development are breakeven at a $60/bbl oil price, CFO Brian Gilvary said. About 80% of the projects work at a price under $60. Brent was trading at around $47/bbl on Tuesday and it averaged less than $45 during the third quarter.

BP’s largest operations are in the United States, and for years, the company has been the largest North American natural gas marketer (see Daily GPISept. 10).

Although it has remained one of the top operators in the deepwater Gulf of Mexico (GOM), BP's Lower 48 business had languished for close to a decade before a turnaround was launched in early 2014. Former SandRidge Energy Inc. COO David Lawler was tapped to take over the unit (see Shale DailyAug. 20, 2014).

BP's underlying replacement cost profit in 3Q2015, which is similar to U.S. net earnings, fell by almost half year/year to $1.8 billion from $3 billion, but it was higher than in 2Q2015, when profits were $1.3 billion.

Global Gas Trading Records Profits

The latest results reflect the impact of sharply lower commodity prices -- but also the benefits of the integrated operations, with a strong performance from the downstream segment. In addition, global gas trading profits were higher, mostly from the international liquefied natural gas business.

What has sustained BP through the downturn is in part ironically because of the Macondo well blowout in 2005, which forced the company to become a leaner operation. It has sold and continues to sell billions of assets, and it was forced to make operations more efficient -- a plan that proved prescient ahead of the oil price collapse.

Dudley earlier than most of his peers also had said he expected oil prices to remain in the dumps for the long haul -- and the company was following his lead.

"Last year, we acted decisively to reset BP for a sustained period of lower oil prices and the results are coming through well," the CEO said. "We are now in action to rebalance our financial framework in this new price environment. And I am confident that BP's strong and well-balanced portfolio of businesses and projects gives us the ability to grow value into the future. All of this underpins our strong priority of sustaining our dividend and then growing free cash flow and shareholder distributions over the long term."

By optimizing project economics, phasing spending and through deflation across the industry, BP now expects organic capital expenditure (capex) to be $17-19 billion a year through 2017. It should approach $19 billion this year. This is the third time the capex forecast has been cut. Originally BP had planned to spend $24-26 billion this year; in 2Q2015, it cut capex to about $20 billion for 2015.

"At the range of capex that we've described, we can grow the company moderately," McKay said. It's likely going to be rough to replace diminishing oil and gas reserves at a rate of 100%, which is optimal. "Reserve replacement obviously is going to be weak right now...We do have organic exploration that will continue," but BP is "not sizing to 100% replacement of reserves because we also are working on discovered resources and others that technology will unlock."

Focusing on Developing Projects

The next year may be "lumpy," but there are "viable resources for reserve renewal." BP has "50 or so more projects" that could rotate into the development portfolio and "we are working them hard," as costs are cut and contracts restructured. One big aim is to continue development in the deepwater GOM, where a big portion of the budget is directed (see Daily GPIFeb. 4, 2014).

"The basic point is, between the resources we have in the company and the resized exploration, plus our access to unconventional resources, there's more than enough to renew the hopper."

A few days ago BP and state-owned China National Petroleum Corp. agreed to expand their global partnership, which covers potential shale gas exploration in the Sichuan Basin, as well as global gas trading opportunities (see Daily GPIOct. 21).

"We have more than enough investment options," Dudley said. The list of exploration possibilities are solid enough that "appraisal activities today...could lead us to re-prioritize options that could take us into the next decade" and move some projects more quickly to development. However, "any developments we do have to meet investment hurdles," which would include potential acquisitions.

BP had begun simplifying its organization in 2013, and it continued to benefit over the past year from the decline in oilfield services costs and improved drilling efficiencies.

"Controllable" cash costs for the company since the start of this year are $3 billion lower than in the same period of 2014. By 2017, those annual cash costs are expected to be more than $6 billion lower than they were in 2014.

BP isn't turning a blind eye to potential acquisitions, but selling assets that don't meet the price threshold for development remains the name of the game, Dudley said. Almost $10 billion of properties are expected to be sold this year; the total currently is $7.8 billion. Another $3-5 billion of assets is scheduled for divestment in 2016 before BP returns to a rate of selling around $2-3 billion of assets a year.

Macondo Settlements Progressing

"Divestment proceeds are expected to provide flexibility to help manage both continuing oil price volatility and BP’s commitments in the U.S.," the CEO said.

Over the past five years, BP has maintained gearing in the band of 10-20%, which provides financial flexibility to manage uncertainties, primarily related to the Macondo tragedy. As progress is being made toward completing agreements in principle to settle with the U.S. government and Gulf Coast states, BP now intends to manage gearing with flexibility around a level of 20%.

"Our principal objective is to reestablish the balance in BP's financial framework, with operating cash flow covering capital expenditure and the dividend," Gilvary said. "We are already making strong progress and the plans we have set out will allow us to achieve this without compromising BP's core growth options."

BP reported operating cash flow for 3Q2015 was $5.2 billion.

For the upstream segment, pre-tax underlying replacement cost profit was $800 million, sharply below the $3.9 billion earned a year ago because of commodity prices, but higher than $500 million profit in 2Q2015. Lower costs and a "strong" performance from gas trading overcame the shortfall in prices.

Macondo remains a lingering cost issue. Agreements in principle have been reached to settle all outstanding federal and state claims arising from the tragic blowout, which provide for principal payments of up to $20.8 billion over a period of 18 years (see Daily GPI,Oct. 5). A court hearing is scheduled in March for final consent decree approval.

"BP has successfully adapted to changing circumstances many times in its history and, in a hard time for the entire industry, I believe we will once again successfully take on today's challenges," Dudley said. "We are already in action, with a quality portfolio and clear plans for the future, underpinned by enduring principles. I am confident BP will continue to deliver value into the years and decades ahead.

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