03 October 2010

BP: Look Ahead to September 2010 Quarterly Results

This post describes our model of BP's (NYSE: BP and LON: BP) Income Statement for the third quarter of 2010, which ended on 30 September.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing background information about BP and the business environment in which it is currently operating.

BP p.l.c. is a major Integrated Oil and Gas firm.  Formerly known as British Petroleum, BP became a behemoth by merging with Amoco in 1998 and acquiring Arco soon thereafter.

Headquartered in London, BP has worldwide interests.  The company operates Alaskan oil fields and pipelines, and it had become the "largest producer in the Gulf of Mexico."

BP owns 50 percent of the TNK-BP joint venture with Russian partners.

The tragic explosion on 20 April 2010 of the Deepwater Horizon drilling rig in the Macondo area of the Gulf of Mexico resulted in the loss of 11 lives and the release of an estimated 5 million barrels of crude oil.  BP had obtained the rig, which was destroyed, from Transocean (NYSE: RIG).

The flow of oil from the damaged well was permanently stopped in September.

As a consequence of the events in the Gulf of Mexico, before and after the explosion, BP's board ousted CEO Tony Haywood and replaced him with a safety-conscious Bob Dudley.  It didn't help Mr. Haywood that the Gulf disaster followed a string of other BP difficulties, including tragedies, maintenance problems, and market manipulation allegations.  Haywood himself had risen to the top job after an earlier ignominious leadership change.

To cover the disaster's costs, including a $20 billion compensation claims fund, BP recorded a pre-tax charge of $32.2 billion in second quarter of 2010.  BP might sell as much as $40 billion of assets (up from $30 billion) over an 18-month period to raise cash.  In one deal, Apache (NYSE: APA) agreed to spend $7 billion to purchase assets in Canada, Egypt, and the Permian Basin of West Texas and New Mexico.

BP's market value fell from $190 billion in April 2010 to $90 billion in June.  The market value has since recovered to about $130 billion.

In 2009, BP achieved profits of $16.6 billion on sales and other operating revenues of $239 billion.  BP produced 4 million barrel-of-oil equivalents per day

The price of crude oil in 2010 has generally been around $80 per barrel.  This price has settled above the $40 low in early 2009 when the global economy seemed most fragile, but well below oil's $140 peak in 2008 peak.  Crude's price tends to move up or down based on changing perceptions of how economic conditions will affect the demand for oil, how geopolitical and other forces will affect the supply, the availability of new energy sources, compliance with output quotas, and the value of the dollar.

Natural gas prices also soared and crashed in 2008, but spot prices haven't had much of a rebound.

BP lost $17.15 billion ($5.41 per diluted ADS) in 2010's second quarter, which ended 30 June.  The loss was, of course, a consequence of the charges associated with the Deepwater Horizon explosion and cleanup. 

Readers wanting to take another look at BP's June 2010 quarter might wish to review our Income Statement analysis.

We're now ready to look ahead to BP's results for the September 2010 quarter.

BP makes scads of operating information available to investors, and the company's annual strategy review on 2 March 2010 with the financial community is a good resource.  However, the company does not issue quarterly guidance that directly translates into Income Statement figures.  So, we have to examine the fundamentals. 

The company's Revenue is dependent, for the most part, on how much oil and natural gas it produces and refines and the prices at which various energy products are bought and sold.  It is sometimes also necessary to assess geopolitical and natural forces (e.g., weather) that can significantly affect productivity and prices.  For numerical data, the extensive trading conditions figures the company makes publicly available is especially helpful.  From this source, we learn:
  • The average price per barrel of Brent crude oil increased from $68.08 in the third quarter of 2009 to $76.67 in the same quarter of 2010. 
  • The benchmark price of Russian oil has remained between $35 and $36 per barrel.
  • U.S. natural gas prices rose from $3.39/mmbtu to $4.38, but they were over $5 in the first quarter of 2010.
  • BP's Refining Global Indicator Margin has varied erratically between 3.4 and 5.5 in the last year and is now about 4.6.
We estimate BP's Revenue in the third quarter will be around $75 billion, just slightly more than Revenue of $73 billion to $74 billion in each of 2010's first two quarters.   Our estimate is 13 percent more than Revenue of $66.2 billion in the third quarter of 2009.

BP's Gross Margin, as we define it, was between 19 percent and 22 percent in 2009 and the first quarter of 2010, but the margin declined to 16.5 percent in the disastrous second quarter.  We are choosing 18.5 percent as our target for the third quarter, in part because refining margins remain weak but also because of concerns about cost control.  In other words, we expect the Cost of Goods Sold  -- which we define for BP to be Purchases, plus Production and Manufacturing Expenses, plus Production and Similar Taxes -- to be 81.5 percent of Revenue.  Combining this ratio with our $75 billion Revenue estimate yields a CGS prediction of $61.1 billion.

Depreciation (including Depletion and Amortization) expenses will probably be near $3 billion, as they have been for some time.

We also expect Exploration costs around $200 million based on the expenses reported in recent quarters.

Sales, General, and Administrative costs, what it calls Distribution and Administration Expenses, should also be around $3 billion in the quarter.

It seems prudent to expect an operating charge in the third quarter to cover Gulf of Mexico expenses that were greater than previously estimated.  One report indicated that expenses were about $4 billion more than expected.  Since this might not translate directly into an accounting charge, if there is one at all, we are estimating an operating charge equal to half the added expense, or $2 billion.  This estimate is obviously quite uncertain.

Rolling up the Revenue and Operating Expense estimates yields Operating Income, as we define it, of $5.68 billion.  This amount, if realized, would be 12 percent less than last year's $6.42 billion.

For non-operating income and expense items, we are assuming BP will realize a $1 billion gain on asset sales, net of impairments, as in the second quarter.  We also expect to see a $100 million net expense for interest and finance charges and income.

These figures bring our estimate for pre-tax income to $6.6 billion.

If the income tax rate is 40 percent, and if after-tax earnings from jointly controlled entities and associates total $800 million (a rough estimate, at best), Net Income will be about $4.75 billion ($1.49/ADR).  The accuracy of this estimate is greatly dependent on the assumptions for special operating expenses, gains/losses on asset sales, and joint-venture income.

Please click here to see a normalized depiction of the projected results next to BP's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

1.  Two figures were extracted from the BP's Strategy Presentation [2.5 MB pdf] of 2 March 2010.
2.  The source for the crude oil and natural gas price charts is http://www.metalprices.com/

Full disclosure:  Long BP at time of writing.  No position in any other security mentioned.

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