Technology has played a big part in the Lower 48’s performance, allowing it to improve efficiency while cutting jobs. Drilling has also become more factory-like, to make new wells more economic. US shale has boomed over recent years and is on the cusp of turning the country from being reliant on imports to one that can export. The current drive has been producing oil, where the US is forecast to add half of the world’s new oil capacity over the next five years. This has been thanks to new technology and more attractive economics encouraging the entry of oil majors that have transformed an industry which has traditionally been fragmented.
But while its rivals have been expanding their footprints in the US and building out their oil portfolios BP has, until now, been unable to effectively compete in an increasingly competitive mergers and acquisition (M&A) environment. Lower 48 predominantly produces gas at present, with just 10,000 barrels of oil being pumped out daily.
The new assets will rebalance the company’s product mix. Of BP’s total production onshore the US at present, 86% is gas with the other 14% being liquids (mostly oil). Meanwhile, 83% of its resources in the ground were gas versus just 17% liquids. After integrating BHP’s assets, BP’s output will comprise of 73% gas and 27% liquids and its resource base will be made up of 71% gas and 29% liquids. The firm’s current resources onshore the US stand at 8.1 billion barrels of oil equivalent (boe) and the BHP assets will add a further 4.6 billion barrels. Overall, it suggests that the new operations will hold about 10% of BP’s total resources.
The deal is transformational for BP and makes the area a new heartland for the business. The firm is ambitious with its plans to grow oil output in order to catch up with its rivals, with plans to grow those 10,000 barrels being produced each day to 200,000 barrels daily ‘by the middle of the next decade’.
BP boosts daily production by 190,000 barrels with plans for more
BP currently produces 3.6 million boe per day, with 744,000 barrels coming from its US operations: with the Gulf of Mexico contributing 320,000 barrels, Alaska 109,000 barrels and its US onshore operations 315,000 barrels. That means its US operations as a whole account for about 21% of BP’s global production, with US onshore accounting for just 8.8%. After the new assets have been integrated (and taking into account anticipated asset sales in Alaska), BP will produce 25% of all its oil and gas from the US, with onshore operations contributing at least half of that.
The acquisition pushes shale to the forefront of its portfolio and will make BP a formidable player onshore the US alongside other major players like Exxon Mobil, Chesapeake Energy, Whiting Petroleum, Devon Energy, Anadarko Petroleum and Pioneer Natural Resources, to name a few.
BP was already working toward a target of growing annual production by 5% out to 2021 but has said the new BHP assets will be accretive to that, essentially representing a cautious upgrade to guidance.
BP to start with the Eagle Ford but eyes Permian for longer-term growth
‘Returns in the Eagle Ford that we’ve got today are probably higher than they are in the Permian, and that’s where we will direct a lot of the capital on day one,’ – BP.
BP’s new assets are located over three prominent basins in the US, where the speed of development will differ. It provides the opportunity to improve the operations through economies of scale. The immediate job will be to make the new assets profitable, having booked an $800 million pre-tax loss in the 12 months to the end of the June 2018.
The addition of BHP’s assets in the Haynesville basin will double BP’s existing production from 60,000 barrels of oil equivalent per day (boepd) to 120,000 boepd (all gas), triple its acreage and add a further 720 gross drilling locations in East Texas and Louisiana.
The plan at Eagle Ford is similar and where most of BP’s initial attention will be focused. BP plans to apply new drilling techniques to make the operations more profitable and yield synergies by combining them with its existing assets.
As for the assets in the Permian, BP plans to start seriously stepping up its work over the next couple of years to allow new infrastructure to come online, with the area regarded as the most attractive basin for longer-term growth. Although the Permian assets are already producing, this area will be a longer-term focus for BP, which says the acquisition means it has ‘a deep and highly-economic inventory for future drilling’.
There is a severe lack of pipeline and other infrastructure capacity in the Permian, but BP expects new capacity to come online over the ‘next one to two years’. In the meantime, the business plans to shift its initial attention to the Eagle Ford.
BP trumped its Permian expansion by stating its new acreage, centred in one of the 27 counties that span the basin named Reeves County, is ‘in the core of the core’, claiming 72 out of the 500 rigs in the Permian are concentrated in the area. That too demonstrates the prominence of the Permian as a whole, bearing in mind there are thought to be 1000 active rigs onshore the US as a whole at present.
BP believes purchase of US midstream assets underappreciated
‘I think (midstream) is a part of the story that may not have been captured externally as we see it,’ – BP.
On the point of infrastructure, attention on BP’s landmark deal has been focused on the producing assets and the wider potential of the acreage it has acquired, but the firm is also snapping up some midstream assets as part of the purchase, which it thinks has been underappreciated by the market.
The company said it was securing a thousand miles of oil and gas and water gathering systems as well as five gas facilities, the majority of which is held under a joint venture with Kinder Morgan in the Eagle Ford. However, it has also bought some gas and water pipelines in the infrastructure-starved Permian.
BP said these midstream assets are ‘extremely valuable pieces of infrastructure’ that demonstrates the ‘valuation brick’ of the deal.
BP sets conservative cost synergy target of $350 million
‘This is delivered in the near term with the addition to our portfolio of producing upstream assets alongside a valuable midstream asset position in the Permian and Eagle Ford basins,’ – BP.
Overall, BP is aiming to deliver annual cost synergies of at least $350 million once it has integrated its new assets into it existing operations, although it admits this is a very conservative number to suggest cost savings and revenue improvements could be far greater than currently anticipated.
BP certainly expects those synergies to be higher over the longer term, stating that it sees potential to squeeze further value out of the assets by drilling for new resources.
BP confident it can stay within financial framework despite splashing out
‘The financial repositioning we have delivered in recent years and the confidence we have in our outlook for free cash flow allow us to take this extremely attractive opportunity now without any adjustment to our financial frame. This is fully consistent with our commitment to financial discipline and creating value for shareholders. With our planned additional divestments and buybacks, we expect to deliver this major step forward for a net investment of around $5 billion,’ – Brian Gilvary.
BP has also been conservative when it comes to the price assumptions it had used when calculating the value of the deal, basing it on a WTI price of $55 per barrel, a Midland discount of $7 per barrel in the near term (Midland is a type of WTI that trades at a discount), and a Henry Hub gas price of $2.75 per million British thermal units (BTU). WTI has not traded at that level since late last year and has comfortably remained over the $65 mark for most of 2018, while the average discount to Midland was just over $10 in May, implying that BP believes this discount will narrow as infrastructure and capacity comes online. Henry Hub prices currently stand at about $2.75 per BTU.
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At the bottom line, this means the company can take advantage of further upside at higher prices, like now, but fall back onto a cushion should oil prices decline.
The oil giant has not had to shake up its financial framework in order to complete the deal, which will be a boost to earnings immediately and contribute an additional $1 billion of free cash flow by 2021, to take the total to $14 to $15 billion. The purchase is ‘fully accommodated’ within its existing financial plans, BP says, highlighting that the price actually works out to be a net investment of only $5 billion, taking its plans to sell off assets into account.
Annual organic capital expenditure will remain between $15 billion-$17 billion per year to 2021 as previously guided, and gearing will stay between 20%-30%. Gearing stood at 27.8% at the end of June.
Organic capex has been falling as BP’s cost efficiency improves. In addition to lowering the cost of drilling new wells, the company is also bringing major new projects online at well below cost, typically 15%-20% under budget. Its new Shah Deniz 2, one of the largest projects in the world, is currently on track to be completed at 20%-25% lower than estimated, and it is aiming to halve the well costs in the Gulf of Mexico in the short term.
BP currently ploughs about $1 billion each year into its onshore US operations but following the acquisition it expects this to rise to $2 billion-$3 billion annually over the next few years, which it believes it can accommodate within its existing organic capex budget.
Is BP about to rise above the rest after years of being held back?
BP has managed to keep up with its peers over recent years, despite the costly Deepwater Horizon oil spill which has held back its ability to grow and step up shareholder returns as many would have liked. But BP shareholders should look to the future with optimism following the latest developments.
The purchase should give investors the confidence that BP is now free from the shackles that had limited its M&A muscles, and that it is able to secure the assets it needs to provide both short and long-term growth, and that returns are heading on an upward trajectory after it made the first lift to the dividend in years.
BP has made assurances that it can accommodate such a large acquisition without breaking from its existing financial framework. But the fact it has based that on setting itself some conservative targets suggests there is the possibility of even further upside to the deal than BP has already guided to.
However, some believe BP could look to spin-off the Lower 48 business onshore the US due to the unit’s success since being separated out. This is not uncommon for natural resource companies but BP told analysts that it is very comfortable retaining full ownership of Lower 48. While that is not on the cards for now, it will be a question that investors will revisit once the new assets have been fully integrated.
BP shares have outperformed both the FTSE 350 Oil & Gas Producers Sector Index and its closest rival Shell over the past 12 months and since the start of 2018. In fact, BP has outperformed all Big Five oil producers over the same time periods, apart from French firm Total, with US producers ExxonMobil and Chevron both having actually lost ground since the start of the year.
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