Morning Note: Market news and positive update from BP.

Market News

US equity markets drifted lower last night – S&P 500 (-0.3%), Nasdaq (-0.2%) – as hopes for imminent interest rate cuts faded. This morning in Asia, a rally in Chinese shares accelerated after authorities intensified rescue efforts, defying broader weakness in Asia: Hang Seng (+4.1%); Shanghai Composite (+3.2%). The gains came after Beijing took more steps to stem a stock rout, including widening trading curbs on certain investors and a pledge by the sovereign wealth fund to further increase holdings of exchange-traded funds. The securities regulator said it will encourage other long-term funds to boost stock holdings and support company buybacks.

However, Bloomberg notes that a momentous shift is underway in global markets as investors pull billions of dollars from China’s sputtering economy and direct much of the cash to India. A gold rush has started – with Goldman and Morgan Stanley endorsing India as the prime investment destination for the next decade.

Commodity prices are near an all-time low relative to the S&P 500, signalling to some traders that a comeback for raw materials may be in the works, MLIV said. Also, hedge funds slashed their bullish wagers on commodities futures. Brent Crude trades at $78.20 a barrel, while gold is $2,025 an ounce.

UK retail sales growth slowed to 1.2% in January, the BRC and KPMG said, as consumers tightened their purse strings. Huw Pill said the Bank of England may lower rates this year as a “reward” to the economy for bringing inflation down. CPI growth doesn’t need to fall all the way to the 2% target before the cuts can begin, the central bank’s chief economist added. Sterling buys $1.2560 and €1.1676. The FTSE 100 is currently trading 0.9% higher at 7,679, with BP (see below) leading the way.

Traders are most concerned about liquidity in 2024, as they brace for another year of volatile markets, a JPMorgan survey showed. It’s the biggest concern about market structure, ahead of regulatory change and data costs. In some cases, it’s prompting traders to reduce their liquidity providers to a smaller number of trusted counterparties.

Source: Bloomberg

Company News

BP has today released Q4 results which were better than market expectations. The group increased its dividend by 10% and raised its share buyback target. As a result, returns in both 2024 and 2025 are expected to amount to more than 11% of the current market cap. In response the shares have bounced by 6% in early trading.

BP is gradually transforming from an International Oil Company (IOC) to an Integrated Energy Company (IEC), a strategy that will continue under the new CEO Murray Auchincloss, albeit 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 (c. 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 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 December 2023, underlying replacement cost profit – the key measure of the group’s performance – fell by 38% to $3.0bn, albeit better than the market forecast of $2.8bn. This reduction mainly reflects lower price realisations and the impact of significantly lower refining margins, partially offset by a strong gas marketing and trading result. By division, the results were: gas & low carbon energy (-44%); oil production & operations (-20%); and customers & products (-58%). Upstream production rose by 2.6% in the year to 2.3m b/d.

Cost discipline remains very strong – during the year, upstream production costs fell by 5% – as does operational performance in terms of upstream plant reliability (95%) and refining availability (96%). The focus is now shifting to the downstream division where digitalisation could again significantly reduce the cost base.

The group started four major hydrocarbon projects in 2023, including Seagull which is expected to add around 15,000 barrels of oil per day of net production by 2025. Momentum in low carbon areas continued – during the quarter, the group announced the acquisition of the 50.03% interest in Lightsource BP, the developer and operator of utility-scale solar and battery storage assets, it does not already own.

Operating cash flow fell by 31% to $9.4bn, including a working capital release of $2.1bn. The group received $1.8bn of disposal proceeds from non-core assets in the 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 year was $16.3bn (including $1.1bn of M&A), just above the guidance of $16bn. The target for 2024 and 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 to maintain corporate focus.

Net debt was $20.9bn, a touch lower than last year, with gearing at 19.7%. 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, equating to a full-year yield of 5%.

In addition, the company is committed to returning at least 80% of surplus cash flow to shareholders, an increase from the previous target of 60%. The higher target is driven by the strong balance sheet and increased confidence in the business. The $1.5bn quarterly share buyback programme announced with the Q3 results was completed last week. Today, the group has announced a further $1.75bn buyback from the $2.75bn of surplus cash flow generated in Q4. The group has also committed to $3.5bn of buybacks in H1 2024 and a total of $14bn by the end of 2025 (i.e. at least $1.75bn a quarter).

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 consider 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.

Source: Bloomberg