Morning Note: Market news and an update from BP.

Market News

The yield on the US 10-year Treasury held below 4.5% as the Federal Reserve’s Thomas Barkin said he expects high rates to slow the economy further and cool inflation to the 2% target. John Williams said eventually there will be rate cuts — but the decision on when will depend on the totality of the data. This follows last Friday’s colder-than-expected jobs report – non-farm payrolls in the US rose by 175,000 in April, firmly below market expectations of a 243,000 increase, while the unemployment rate unexpectedly ticked up to 3.9%.

US equity markets also rose last night on interest rate optimism: S&P 500 (+1.0%), Nasdaq (+1.6%), while markets were mixed this morning in Asia: Nikkei 225 (+1.6%); Hang Seng (-0.5%); Shanghai Composite (+0.3%). The yen dropped after Japan’s top FX official said there’s no need to intervene if the market is functioning properly. The FTSE 100 is currently trading 1.1% higher at 8,305.

Geopolitical tensions rose as Israel rejected a cease-fire proposal that was backed by Hamas and is pushing ahead with its operation in Rafah. Gold trades at $2,319 an ounce. Goldman Sachs said a gold rush by emerging market central banks will spur a rally. It reiterated its call for bullion to hit $2,700 by year-end.

UK consumer spending remains subdued. April BRC like-for-like retail sales fell by 4.4%, versus expectations for a 2.0% decline. Barclaycard said UK April consumer spending fell 4.0% year on year, the lowest since February 2021. Sterling trades at $1.2540 and €1.1650.

Source: Bloomberg

Company News

BP has today released Q1 results which were below market expectations. A new target to remove at least $2bn of cash costs by the end of 2026 has been announced. The group increased its dividend by 10% and announced another $1.75bn share buyback. As a result, returns in both 2024 and 2025 are expected to amount to around 12% of the current market cap. In response the shares are little changed in early trading.

BP is gradually transforming from an International Oil Company (IOC) to an Integrated Energy Company (IEC), with greater focus and increased efficiency.

By the end of the decade, the company aims to have built a portfolio of transition growth engines (TGEs), with investment expected to reach $7bn-$9bn a year in 2030. Half will be invested where BP has established businesses, capabilities, and track record – bioenergy, convenience, and EV charging – with the other half in hydrogen and renewables & power. EBITDA (i.e., cash profit) from TGEs is expected to grow to $3bn‑$4bn in 2025 and $10bn-$12bn in 2030 (i.e. 20% of group profit).

BP is not abandoning hydrocarbons – far from it. Instead, it is ‘high-grading’ its business towards a focused portfolio of resilient high-quality oil and gas projects that generate premium free cash flow. This will help meet near-term demand for secure supplies of oil and gas, generating additional earnings that can further strengthen BP and support investment in its green transition. The incremental investment will target shorter-term, fast-payback projects that maximise value and deliver rapidly with minimal new infrastructure. Oil and gas production will be around 2.3m barrels a day in 2025 and 2.0m b/d in 2030, 25% lower than in 2019.

The group is planning to deliver at least $2bn of cash cost savings by the end of 2026 relative to 2023, around 10% of the total. This will be driven by high grading its portfolio, digital transformation, supply chain efficiencies, and the use of global capability hubs.

The overall investment of $14bn-$18bn a year includes acquisitions, providing some reassurance the company won’t engage in large-scale, value-destroying M&A. The company is targeting group EBITDA of $46bn-$49bn in 2025 and $53bn-$58bn in 2030 in a $70/barrel oil price environment, and return on average capital employed of over 18%, which it achieved in 2023.

In the three months to 31 March 2024, underlying replacement cost profit – the key measure of the group’s performance – fell by 45% to $2.72bn, below the market forecast of $2.94bn. This reduction mainly reflects lower gas realisations, lower industry refining margins, a strong gas marketing, and trading result compared with an exceptional result in Q1 2023.

By division, the results were: gas & low carbon energy (-52%); oil production & operations (-6%); and customers & products (-53%). Upstream production grew by 2.1% to 2.4m b/d, while Brent averaged $83.16 a barrel.

Cost discipline and operational performance has been strong, although in this quarter, upstream production costs rose by 4.7% and refining availability slipped to 90.4% due to the impact of the Whiting refinery outage. The focus has now shifted to the downstream division where digitalisation could again significantly reduce the cost base.

Strategic progress continued in the hydrocarbon business with the start-up of the new Azeri Central East (ACE) platform in Caspian Sea. Momentum in low carbon areas continued – BP’s Archaea Energy recently brought online its largest Archaea Modular Design (AMD) renewable natural gas (RNG) plant in Kansas City, Missouri.

Operating cash flow fell by 34% to $5.0bn, including a working capital build of $2.4bn. The group received $413m of disposal proceeds from non-core assets in the quarter and is targetting $2bn-$3bn for the full year. The $25bn target by 2025 remains in place, although encouragingly, the group is focused on generating value from disposals and would let its target slip if it meant generating increased proceeds.

Capital expenditure in the quarter was $4.3bn (including $0.3bn of M&A). The full-year guidance is $16bn, expected to be weighted to the first half. The target for 2025 is also $16bn. The group has made several acquisitions in recent years, with the focus on ‘counter-cyclical opportunities’. Looking forward, although the group has the financial capacity to undertake further M&A, they are only expected to make one or two purchases, ensuring corporate focus is maintained.

As expected, net debt rose in Q1 from $20.9bn to $24.0bn, mainly reflecting a working capital build plus phasing of capex and divestment and other proceeds. Gearing is 22% and the group remains committed to maintaining a strong investment grade credit rating.

The group targets a resilient cash balance point of around $40 per barrel Brent oil price. This provides the capacity to grow its dividend by around 4% a year at around $60/barrel. Today, the group has declared a quarterly dividend of 7.27c, 10% higher than last year, implying a full-year yield of 4.5%.

In addition, the company is committed to returning at least 80% of surplus cash flow to shareholders. The $1.75bn quarterly share buyback programme announced with the Q4 results has been completed and as expected, the group has announced a further $1.75bn programme. The group has previously committed $14bn of buybacks by the end of 2025. This means the annual return to shareholders could amount to 12% of the current market cap.

We believe decarbonisation can’t happen at the flick of a switch – oil and gas will remain part of the global energy mix for decades, with demand driven by population growth and higher incomes, particularly in developing countries where the desire for energy intensive goods and services like cars, international travel, and air conditioning is rising. We also believe the production of the materials needed to transition to net zero can’t happen without using hydrocarbons. At the same time, reduced investment in new production, partly because of environmental concerns, is increasingly leading to constrained supply.

Against this backdrop, BP is looking to reduce emissions in a way that delivers attractive returns for shareholders at a time of macroeconomic uncertainty. Although execution of the group’s low carbon strategy, particularly in terms of capital discipline, will have some impact on the share price, far more important in the medium term will be commodity prices and cost cutting, and the cash flow and shareholder returns generated as a result.

The shares have drifted lower over recent months and remain on an undemanding valuation, both in absolute terms and relative to the US majors, which fails to discount the potential for free cash flow generation and shareholder returns. We believe they also provide something of a hedge against inflation, while recent consolidation in the sector – Exxon buying Pioneer and Chevron buying Hess – provides further support. We note the recent press report regarding ADNOC, the UAE national oil company, eyeing the company as a bid target, although discussions didn’t progress further than initial conversations.

Source: Bloomberg