A recent special report in the Wall Street Journal (Innovations in Energy) suggested investors should “get ready for peak oil demand”, but then just as quickly conceded that “forecasts for peak oil demand diverge by decades.”
Peak oil is highly theoretical and refers to when the world reaches the point where oil coming out of the ground reaches its maximum, or the most oil (and gas) getting extracted from the ground. Yet it also refers to when demand might reach its highest absolute level. Demand for oil stems from consumers driving cars and any transportation need, industrial uses and several other factors.
The International Energy Agency (IEA) sees demand peaking sometime around 2040. Exxon Mobil Corporation (NYSE:XOM) and Chevron Corporation (NYSE:CVX) don’t see peak demand any time soon (not within many decades), while others see it sometime between 2025 and 2030. Royal Dutch Shell plc (ADR) (NYSE:RDS.A, NYSE:RDS.B) sees it sooner, so it is shifting to renewable energy to hedge its oil and gas exploration and production (E&P) operations.
Energy giant BP plc (ADR) (NYSE:BP) agrees with the IEA and projects peak oil demand sometime around 2040. I think a fair conclusion is that no one (including the experts and companies that deal with energy on a daily basis) really knows for sure. Which is OK — demand and supply fluctuate in all industries and no one knows for certain when imbalances will occur.
In the nearer-term high supply, ample production from fracking firms in the United States and a slow shift to renewable energy have continued to depress oil prices. Prices have fallen by 50% to around $50 per barrel of oil. Natural gas prices are also bumping against multi-year lows.
Just a couple of years ago, oil prices hovered closer to $100 per barrel. The largest industry players were throwing off lots of cash flow and spending billions of dollars to find more oil. There was an ample spread between the costs to extract oil and gas from the ground and sell it in the marketplace.
But for the past few years now, the big players haven’t generated enough cash from their operations to cover their capital expenditures (capex) to maintain and invest in new oil and gas assets. That has been a huge problem, but it appears to be subsiding and BP stock seems to be ahead of the curve compared to archrivals.
A Deep Dive on BP’s Cash Flow
If you agree with BP’s definition of its cash flow, it is one of the first large, integrated oil firms to be turning the tide on the amount of cash it brings in against what it spends. Excluding payments it is still making for the horrific Gulf of Mexico (Deepwater Horizon) oil spill back in 2010, it said first quarter cash flow was $4.4 billion. This is against only $1.3 billion in “working capital build.”
The reported figures tell a slightly different story (I’ll leave it up to you to do a web search on how companies issue “pro forma” results that mask financial reality). Including payments for the oil spill, cash flow was a more modest $2.1 billion. And capex on the cash flow statement (“total cash capital expenditure”) was $4.1 billion. The gap was made up for by the issuance of $2.8 billion in debt.
BP management expects to pay out another $4.5 billion to $5.5 billion to cover payments for the Deepwater Horizon debacle. Then the payouts should fall to $2 billion next year and about $1 billion in 2019. That would be a relief to investors — it has been many years of payments, and (an astounding level of!) collective payments that will reach as high as $70 billion to pay for cleaning up the spill, fines and compensating parties adversely affected.
Analysts project another $23 billion in total payouts over the next couple of decades, which is surprisingly reasonable on an annual basis.
BP estimates total capex for this year between $15 billion and $17 billion. It sees a similar annual range through 2021. Operating cash flow has averaged almost $21 billion over the last three years, though it fell below $11 billion last year. It is also still divesting less strategic assets and sees proceeds of $4.5 billion to $5.5 billion this year.
Bottom Line on BP Stock
The point of obsessing about BP’s cash flow is to first make sure it can survive. The fact that it survived the Deepwater Horizon disaster speaks to the financial flexibility and assets that large energy companies possess. Now that BP stock is through the worst of it, the future should be much brighter for shareholders. And although total debt levels exceed $51 billion, interest expense looks manageable.
BP stock also sports a 6.5% dividend yield that requires $5 billion in annual cash flow to support. Based off the current projections, the dividend payout looks safe.
It’s tough to see BP rallying sharply until oil prices rebound, but it is safe to assume the company can survive in the current low-price environment. Peak oil is many years off, but oil could rally closer to $60, or even $70 per barrel within a couple of years. If and when that happens, BP stock could rally to above $40 per share, and shareholders could rest easier after a very tumultuous decade for the company.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.
