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BP Leveled by North American Operations Losses

A write-down on U.S. natural gas resources, a decision to cancel a flagship drilling project offshore Alaska, and the continuing impact of the Macondo well blowout pummeled BP plc's profits in the second quarter.

Net losses totaled $1.39 billion (minus 7.29 cents/share) in 2Q2012, compared with year-ago profits of $5.72 billion (29.9 cents). Replacement cost profits (RCP), which strip out gains and losses from inventories, plunged 96% to $238 million from $5.41 billion. Revenue fell to $94.9 billion from $103.95 billion.

Adjusted RCP, or "clean" replacement costs, which European producers use to exclude write-downs, plunged 35% year/year to $3.7 billion from $5.7 billion and fell from $4.8 billion in 1Q2012. Wall Street had expected BP to earn $4.49 billion. The latest quarter was the lowest RCP report for BP since 2Q2009, when the company was hit by the severe global downturn.

The write-downs primarily were North American-related. BP wrote off a total of $2.1 billion on the shale gas portfolio because of low gas prices, and on the canceled Liberty drilling project on Alaska's North Slope (see NGI, July 11). The remaining $2.7 billion included a write-down on the U.S. refinery and chemicals business. BP also recorded a pretax loss of $847 million for additional Macondo-related litigation costs.

"I'm not satisfied with second quarter results, but we are in the midst of a major transformation, which will take some time," CEO Bob Dudley told analysts during a conference call. "We will continue to transform the company beyond the quarter...There are a number of uncertainties but we continue to focus on the improvement of longer-term priorities that don't show up in the results."

Volatile commodity prices hit North American operations particularly hard, said CFO Brian Gilvary. "Dated Brent declined sharply throughout the quarter and was $9.00/bbl lower than in the first quarter," Gilvary said. "Henry Hub prices reached 10-year lows below $2/Mcf because of warm winter weather and high inventories that forced gas to compete aggressively with coal..."

Several planned and unplanned items "weighed on the North American gas business," he said. Because of the one-off items, "North American business was operating at a loss" in 2Q2012.

Dry natural gas drilling in North America is coming to a standstill, Dudley said. BP today has seven rigs still drilling dry natural gas targets in the United States but the "rig count likely will be down to five by the end of the year," he said. Most of company's dry gas unconventional focus to date has been in the Fayetteville Shale.

"This is a very, very significant resource base," Dudley said of unconventional gas, but it's not making enough money today. "We've moved out of the Fayetteville and into more wet gas like the Eagle Ford."

BP's North American gas drilling operations outlook is "based on prices below $4.00/Mcf."

A lot of BP's North American gas "has a fairly fast payback...we are very responsive to the price environment," said the CEO. He noted that gas prices "have moved up from a $1.94 low and closed at $3.21" last Monday. "There's some incentive there and we are heading in the right direction to get back to work. But we are prudently planning to keep activity low and focus on the liquids-side of things."

BP is "looking to see if it might expand" in the liquids-rich Utica Shale after securing a leasehold earlier this year, Dudley said. The energy giant in March bought close to 84,000 net acres in Trumbull County, OH (see NGI, April 2). Dudley told analysts he was in Ohio last month to check on the new acquisition and to meet with Gov. John Kasich.

"I spoke with the governor to get a sense of the commitment by the state to industry and I got nothing but encouragement from that, of having BP in Ohio...It's one area we are looking at. We are being measured and careful about it and not jump in too deeply but the Utica has additional promise."

BP isn't the only producer looking for liquids-rich targets, Dudley noted.

"Nobody's had enough of it. Everybody feels having more is the right thing to do...all the way down to the oil shales. Ours has been redirecting to it step by step by step...first in the Eagle Ford and now the Utica. We are looking to see if we might expand there..."

The "most significant event" to impact BP during 2Q2012 in terms of planned maintenance activities "was the complete replacement" of subsea systems at BP's Atlantis platform in the deepwater GOM, said Gilvary. The turnaround project, which was planned, required the facility to be shuttered for the period, which resulted in the loss of about 86,000 boe/d in output.

"All of this will take time, but it is important investment that will enhance safety and reliability for the long term," said Dudley. "As we deliver this major transformation, we are also committed to generating sustainable efficiencies in our operations."

Going into 2013, "we expect earnings momentum to build," he said. Among other things, BP's final payments into the Macondo trust fund are to be completed by the end of this year.

Natural gas and oil production, excluding the Russian joint venture TNK-BP, averaged 2.275 million boe/d in 2Q2012, compared with 2.457 million boe/d in 2Q2011. Its share of TNK-BP production, which it is negotiating to sell, was 1.016 million boe/d, up from 976,000 boe/d a year earlier.

BP expects to increase operating cash flow in 2014 from 2011 levels by 50%, "in a $100/bbl oil price environment," said Dudley. "This is expected to be driven both by the completion of contributions into the Gulf of Mexico Macondo trust fund -- expected by the end of 2012 -- and the delivery of major projects, focused on 15 new higher-margin upstream projects scheduled to begin production by the end of 2014.

"Six are scheduled to start up in 2012, and two -- Galapagos in the Gulf of Mexico and Clochas-Mavacola offshore Angola -- are now on stream.

"Six rigs are now operational on BP fields in the Gulf of Mexico, with a total of eight expected to be in place by year end." The GOM will continue to be a priority for BP "through at least this decade," said Dudley. "Moving into 2013, we expect earnings momentum to build as we complete payments into the trust fund, as high-value production comes back on line, and as the impact of new projects ramps up."

At the end of June BP had paid a total of $8.8 billion in individual and business claims, and government payments arising from the Macondo blowout. Cash balances in the trust and the qualified settlement funds amounted to $10.1 billion, with $17.9 billion contributed in and $7.8 billion disbursed.

To help pay for the GOM costs, the company since 2010 has agreed to sell assets with a value of $24 billion, Dudley noted. Total divestments are targeted to hit $38 billion by the end of next year.

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