The concept of a "major" oil and gas company has changed a bit over time, as companies like Occidental Petroleum (NYSE:OXY) and Devon Energy (NYSE:DVN) have grown considerably. But regardless of whether you want to argue that Eni (NYSE:E) and Repsol (NYSE:REP) no longer belong on the list, everyone agrees that BP plc (NYSE:BP) is still in exclusive company.
With a market cap in excess of $155 billion and billions of barrels of oil and cubic feet of natural gas in proven reserves, BP is huge. What may be less certain, though, is whether the company can maintain a dividend that currently gives it one of the highest payouts in the energy sector. (Read about the value of dividends in The Importance Of Dividends.)
Performance Was All In Prices
BP reported earnings that certainly look robust at first glance. Who wouldn't like revenue growth of 45% or profit growth of 83%? Performance was just as strong at the segment level with E&P operating profits up 82% and refining and marketing posting 86% growth. (Learn more about the income statement at Understanding The Income Statement.)
What concerns me is the details. Total production was basically flat - with liquids down slightly and natural gas up slightly - and actually down more than 4% on a sequential basis. Likewise, refining production was sluggish (though a hurricane didn't help).
Performance, then, was driven by higher realizations. BP made 57% more from each barrel of liquids and 65% more from each cubic foot of natural gas. As we have seen the prices of oil and natural gas dive back down from their summer peaks, BP's realizations will follow in time.
Disciplined Or Sluggish?
Apart from some deals with Husky and Chesapeake Energy (NYSE:CHK), BP's capital expenditures rose 13% from last year. That figure is problematic when you read about the rate increases from service providers like Schlumberger (NYSE:SLB), Patterson-UTI (Nasdaq:PTEN) or Noble (NYSE:NE), as it suggests BP is not really ramping up its activity level in looking for new energy reserves.
By my calculations, BP has about 12 years' worth of oil in its reserves and 15 years of natural gas. With that in mind, the company will need to either spend more money finding oil "organically" or acquire other companies. The company can afford to be patient and opportunistic, but eventually management will have to choose between holding less cash today or cutting the dividend tomorrow. (Learn how to examine an oil and gas company at Unearth Profits In Oil Exploration And Production.)
The Bottom Line
Oil prices are reaching the point where I believe marginal production gets a little more marginal. I'll admit that trying to tease out the "break-even" cost for various producers or types of oil involves a lot of guesswork, including making certain assumptions about production costs and required rates of return. But I believe we're already below the point where Canadian heavy oil production is economically interesting, and we may be close to the point where some Brazilian deep-water production looks less appealing.
I can't say with certainty where BP's break-even point is, but I don't think the company needs to worry about capital allocation as long as oil stays above $50 a barrel (assuming that the price relationship between oil and natural gas doesn't change dramatically). Even if oil goes below $50, I'm not suggesting the dividend gets cut - the company could reallocate some capital spending and probably has some low-hanging fruit on cost control. I'm just saying that's the point where things get a little more interesting.
BP is a reasonably attractive income-producing energy company, but so is Royal Dutch Shell (NYSE:RDS.A, NYSE:RDS.B). With nothing terribly exciting about BP and many other investment options, I'd stay on the sidelines with this one.