BP Upstream Getting Crushed

Companies / Oil Companies Jan 13, 2016 - 11:47 AM GMT

BP’s announcement earlier of another 4,000 job cuts on top of existing measures designed to ease the pressure of rapidly tumbling oil prices comes as no surprise, especially with crude oil prices tumbling to a brand new multi-year low. The industry has fallen to such depths that the Saudi’s are even contemplating taking a piece of their petroleum empire public to raise desperately needed cash to continue waging their price war. However, the current British Petroleum is on Saudi Aramco, and stands as a shadow of its former self. Now, with oil prices set to stay depressed for an indefinite period of time, BP is trimming what remains of the company to weather the storm while trying to boost shareholder value.

Lower for Longer

The phrase formerly synonymous with interest rates is now used to define the outlook for crude oil prices. With the entirety of the crude oil futures curve pricing $50 per barrel, BP has had to shift away from upstream activities, depending increasingly on downstream operations to make up for the shortfall. As the latest layoff announcement shows, the company intends to slash the exploration and production headcount to the bare bones, especially in high cost projects such as the North Sea wells. Efforts to reduce costs can only go so far and BP cannot eliminate capital expenditures especially in an industry that requires intensive ongoing maintenance and high development costs.

Luckily for BP, its expansive downstream assets ensure that the company has stable cash flows, especially amid improving margins for the business. Refining is one bright spot for the company during the ongoing turmoil with high utilization rates and strong margins keeping revenues afloat for investment in other areas of the business. While the move away from upstream assets will be felt as cash flows improve from cost cutting, it comes at a time when BP is working to expand its LNG presence to diversify revenue streams. However, with energy prices unlikely to rebound in the near future, the company is hunkering down for the time being.

Value Still There

Like the limbo, BP is wondering just how low costs and oil prices can go. The company’s valuation shrunk substantially over the past year with share prices falling -15.5% over the past 12-months. The opening of 2016 has been no peach especially with oil prices crossing below $30 per barrel, dragging down shares further. The key to any sustained rebound in the company’s fortunes remains a reversal in energy prices that will enable BP to reenergize upstream operations.

While BP is likely to be sensitive to falling oil prices as revenues continue their slide, there remain strong incentives for long-term believers in the company’s vision. With a dividend yield topping 8.21% and no plans to cut it soon, investors with patience will be rewarded, especially if demand for LNG improves and BP manages to capture a larger share of the total gas market. Strong refining margins will buoy the company over the near-term and protect dividends, but longer-term the outlook remains challenging, especially for oil related assets.

Another Channel Lower

Technical indicators remain largely in strong confirmation of the predominantly bearish bias that has prevailed in shares over the last year. In a follow up to an earlier article, after trending lower for some time, BP shares managed to breakout to the upside for a brief correction alongside oil prices before sliding once more. Once again, BP shares are trading within an emerging downward trending channel. Ideally, any rebound towards the upper channel line should be taken as an opportunity to sell more with the expectation that prices will return to the bottom of the channel. With shares now in the middle of the range, execution of a short position is not ideal however owing to the entry point.

Value investors looking to catch the falling knife should remain cautious, as oil prices still have room to fall. BP remains below both the 50-day and 200-day moving averages which are currently both trending lower and acting as upside resistance. Support at 325p could prove surmountable and put up a fight against continued downward momentum, especially with the RSI rapidly approaching oversold levels. Ideally, for traders looking to ride the wave lower in crude, waiting for prices rebound towards 350p presents a much more attractive entry point while long-only investors patiently await a better entry point.

Near-Term Risks Versus Value

Given the outstanding fundamental circumstances and a prevailing longer-term trend lower in both BP shares and oil prices, it is hard to imagine that this is the point of reversal in the company’s fortunes. While there is arguably great value locked in the shares from the perspective of dividends, that value can improve further as share prices fall. While in immediate trading shares might bounce modestly especially after nearly a poor start to 2016, rallies should be sold, targeting 325p and below on the downside. Only when the smoke clears from the ongoing global price and production war, will BP shares be on a sustainable path higher.

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