Fitch Ratings has revised the Outlook on BP plc’s Long-term Issuer Default Rating (IDR) to Negative from Stable and affirmed the IDR at ‘A’. A full list of rating actions is at the end of this commentary.The Outlook revision reflects our expectation that BP’s funds from operations (FFO) adjusted net leverage is likely to exceed the guidance level of 2.5x in 2016-2019, reflecting expected cash outflows associated with the 2010 Macondo oil spill and lower oil prices. The largest payment the company is currently facing is the Clean Water Act (CWA) fine, which in the worst case could reach USD13.7bn. BP’s falling proved reserves as evidenced by the organic reserve replacement ratio consistently below 100% have also contributed to the Negative Outlook. The ‘A’ IDR reflects the company’s strong business profile and sufficient liquidity accumulated to handle Macondo-related cash outflows.
BP is a leading global integrated oil and gas (O&G) company with 2014 production of 1.93 million barrels of oil equivalent per day (MMbpd) (excluding equity affiliates) and well-diversified reserve base. Its credit profile is negatively affected by relatively high leverage and continued uncertainty around possible future payments related to the 2010 Macondo disaster.
KEY RATING DRIVERS
Higher Leverage Drives Outlook Revision
Fitch considers that ratings of O&G companies are dependent on how they react to lower oil prices and whether they will choose to keep credit metrics under control through capex, opex and dividend reduction, or resort to more borrowing. BP’s flexibility in responding to low oil prices is constrained by already high leverage and a need to preserve cash in front of still uncertain Macondo-related liabilities.
In February 2015, BP announced a capex reduction to USD20bn in 2015 (compared with the original guidance of USD24bn-USD26bn) and a target to cut opex. Currently strong refining margins and industry deflation should help BP support its profits. However, BP’s operating cash flows will significantly decrease in 2015. Under our rating case, its FFO adjusted net leverage is likely to exceed the current guidance of 2.5x in 2016-2019, up from 2.3x in 2014. For BP’s Outlook to stabilise we expect net leverage to revert to 2.5x through the cycle.
Oil and Gas Super-Major
We view BP’s operational profile as strong, as it remains a leading integrated O&G producer. Its 2014 upstream production of 1.93MMbpd (without equity affiliates, such as the stake in Russia’s Rosneft) was trailing that of Royal Dutch Shell (AA/Rating Watch Negative, 2.5MMbpd), but ahead of Total SA’s (AA-/Stable, 1.5MMbpd) and ConocoPhillips’ (A/Negative, 1.4MMbpd). BP has strong positions in natural gas, including LNG, which accounted for 52% of its 2014 upstream production volumes. Its diversified proved reserves of 9.3bn barrels of oil equivalent (boe) (without equity affiliates) imply a healthy proved reserve life of 13 years, ahead of many of its peers.
Total Macondo Liabilities Uncertain
BP’s total liabilities under the 2010 Macondo oil spill remain uncertain. The main short-term uncertainty lies with the CWA penalty, but there may also be other large cash outflows not yet provisioned, eg, states’ claims under the US Oil Pollution Act. At end-1Q15, BP had provisioned USD43.8bn in total for claims and other related payments, including USD3.5bn for the CWA fine, of which it had paid out USD35.8bn. Under our base rating case, we assume the maximum possible CWA fine (USD13.7bn), but no other unprovisioned payments, which brings total unpaid liabilities to USD18.2bn.
Large Pending CWA Penalty
In the worst case, BP’s penalty under the CWA could reach USD13.7bn. The federal district court in New Orleans ruled that BP had spilled 3.19 million barrels of oil into the Gulf of Mexico, and that it had been grossly negligent in the run up to the disaster. According to the US CWA, BP may hence be fined for up to USD13.7bn; although the fine may be lower through the application of mitigation factors. For example, the court found that BP had not been grossly negligent in its source control efforts following the accident. The court ruling on the amount of the fine could come at any time.
A lower fine will improve our assessment of BP’s liquidity and will push the projected leverage slightly lower. However, this alone is unlikely to result in the Outlook stabilisation. This is because projected leverage would still remain relatively high for a ‘A’ rated oil company, and due to uncertainty related to other possible payments.
States’ Lawsuit Uncertainty Remains
In January 2013, the states of Alabama, Mississippi and Florida presented their claims to BP for alleged losses and property damage as a result of the oil spill. The states of Louisiana and Texas presented their claims later. The total amount claimed by the five states is nearly USD35bn, which BP has not provisioned for, as it believes the claims are unsubstantiated. We do not anticipate the final damages awarded to be as much as USD35bn, but acknowledge that large legal uncertainties remain and note that legal proceedings may drag on for years.
Disposals Bring Cash, Hurt Production
BP’s USD10bn divestment programme for 2014-15 should enhance its liquidity in the face of oil spill payments and lower oil prices, on top of the USD38bn disposals programme completed in 2013. As of April 2015, BP had agreed asset sales for USD7.1bn.
We view positively the company’s ability to raise cash through disposals, when needed. However, coupled with a tight capex discipline and suspended drilling in the Gulf of Mexico they have resulted in falling production. In 2014, BP’s upstream output, excluding equity affiliates, was 1.93MMbpd, 28% lower than in 2009. BP’s proved reserves at end-2014 were down 25% compared with end-2009 numbers. We expect that BP’s production will stabilise and potentially grow over the medium term with a number of relatively large projects coming on stream in the next three years.
Slow Replenishment of Reserves
Operationally, the replenishment of reserves is one of BP’s major challenges. We estimate its five-year organic reserve replacement ratio at 51% (excluding equity affiliates), the lowest among other Fitch-rated oil majors. Compared with peers, BP also has less potential to resort to large acquisitions (such as RDS’s recent acquisition of BG) to maintain reserves due to its relatively high leverage. We do not view this as a significant current threat to production due to BP’s strong reserve life, but could be a risk in the longer term and if it persists, could result in a downgrade.
Rosneft’s Dividends Included
We generally focus on oil and gas production from consolidated subsidiaries because cash flows generated by equity affiliates may not be readily available to service debt at the parent company’s level. In our forecasts, we assume that BP will continue receiving dividends from OJSC OC Rosneft, in which it holds 19.75%, although the amount of dividends will significantly decrease in 2015 and should broadly correlate with oil prices thereafter.
Rosneft’s announced 2014 dividends of RUB87bn (USD1.75bn) mean that BP may be entitled to around USD350m in 2015. Taking into account the political risks, we do not consider BP’s stake in Rosneft, currently valued at around USD10bn, as a potential source of liquidity.
Leverage Set To Rise
Our rating case assumes oil prices gradually recovering to USD80/bbl by 2018, the maximum possible USD13.7bn fine under the CWA and no other unprovisioned cash outflows. Under these assumptions, BP’s FFO net leverage is likely to average 3x in 2017-19 (compared with 2.3x in 2014). Even if the CWA penalty is as low as USD3.5bn (the amount that is currently provisioned by BP), the company’s leverage will exceed our negative rating action guidance. Other unprovisioned payments could drive leverage even higher.
For the Outlook to be stabilised, BP will need to demonstrate good cash generating ability under the depressed oil price environment through more cost cutting initiatives than we currently assume and possibly more disposals in 2016-17.
KEY ASSUMPTIONS:
- Brent gradually recovering from USD55/bbl in 2015 to USD65 in 2016, USD75 in 2017 and USD80 in 2018-19
- Upstream production marginally rising in 2015-16; stable thereafter
- Macondo-related payments: as provisioned except for the CWA, under which we assume the maximum possible penalty of USD13.7bn
- Capex: USD20bn in 2015 as guided; USD17.5bn in 2016 and rising again to USD20bn by 2018
- Dividends payable at USD4bn-USD5bn p.a
- Dividends receivable from equity stakes (including the 19.7% stake in Rosneft) broadly correlate with oil prices
- USD10bn divestment programme fully completed; USD1bn p.a. divested thereafter
RATING SENSITIVITIES
‘A’, Revision of the Outlook to Stable:
- FFO adjusted net leverage at around 2.5x through the cycle
- Organic reserve replacement ratios at 100%; stabilised upstream production
- Lower uncertainty around possible future Macondo-related payments
Upgrade to ‘A+’:
- FFO adjusted net leverage at below 2x through the cycle
- Organic reserve replacement ratios consistently above 100%; growing production
- Elimination of all material uncertainty around possible future Macondo-related payments
Downgrade to ‘A-’:
- FFO adjusted net leverage at above 2.5x through the cycle
- Consistently low reserve replacement ratios
- Deteriorated liquidity, e.g. due to fines and other payments significantly higher than currently anticipated
LIQUIDITY AND DEBT STRUCTURE
At end-1Q15, BP had USD32.4bn in cash and equivalents and around USD1.7bn in uncollected asset sales proceeds. At end-2014, it also reported committed credit lines of USD7.4bn. These amounts comfortably covered the company’s short-term debt of USD8.5bn at end-1Q14 and payments it may face under the CWA.
BP’s liquidity may be challenged if it faces massive charges under the states’ claims. However, we believe the trial will entail years of litigation and are unlikely to be as high as the claimed USD35bn. Furthermore, should plaintiffs be awarded significant compensation from BP, the payments are likely to be spread over several years. Therefore, we view BP’s liquidity as adequate.
The rating actions are as follows:
BP plc
Long-term IDR: affirmed at ‘A’; Outlook revised to Negative from Stable
Senior unsecured debt: affirmed at ‘A’
BP Capital Markets
Senior unsecured debt: affirmed at ‘A’
BP Capital Markets America Inc
Senior unsecured debt: affirmed at ‘A’
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