Global oil giant BP Plc "now sees the prospect of the COVID-19 pandemic having an enduring impact on the global economy with the potential for weaker demand for energy for a sustained period. The pandemic will accelerate the pace of transition to a lower carbon economy and energy system."
Revised long-term price assumption & impairments. BP's long-term price assumptions are now an average of approximately US$55/bbl for Brent from 2021 - 2050...down -27% on previous assumption. The Company has revised its 10-year outlook lower by -30%. On the back of these reduced assumptions, BP is expected to take a post-tax impairment charge of $13 - 17bn.
Implications for Australian Oil & Gas (O&G) companies. On our estimates, the valuation of companies most exposed to long-term price revisions (in order):
- Oil Search (OSH)
- Santos Ltd (STO)
- Woodside Petroleum (WPL)
- Beach Energy (BPL)
Any revisions to long-term price assumptions will likely lead to asset impairments and potentially impact gearing levels. The break-even price for Australian majors is low-to-mid US$30/bbl. However, as we have previously written the break-even price on new projects coming up for FID (final investment decision) requires a much higher price.
Due to the lower oil prices and disruption relating to COVID-19, in our view many O&G companies are likely to be assessing near-term project timelines. We note Woodside Petroleum (WPL) has been forced to revise the timelines for some of their key projects. Scarborough, despite making significant progress on this project over the last few years to get to a FID (final investment decision), WPL has made the decision to push the FID decision to 2021 and need to see stability in oil markets / prices to ensure stability of cash flows to fund the project through the development phase and not put the balance sheet at risk. Investment expenditure for Pluto Train 2 and Scarborough have been deferred to 2021 (if oil prices remain low through 2021, FID for these projects may be deferred again). As previously disclosed by WPL at its most recent investor day (Nov-19), the common market assumption is that the long-term oil price needs to be around US$65/bbl level to deliver an LNG project. Further, WPL noted that at US$65/bbl all its projects meet the Company’s investment hurdles. At US$50/bbl, these projects are NPV positive, but we suspect this is at the lower end of the stress test. The story is similar for global peers like Total SA (among the most efficient producers in the world), which has a break-even price of approximately US$25/bbl however Total's new projects require a price of US$50/bbl (IRR of 15%).
U.S. shale producers are still in the money. The break-even price for U.S. shale producers is in a much better position than it was in previous oil price corrections, with the break-even price for U.S. Permian basin producers at around US$42/bbl. This is comfortably below BP's long-term price assumption and suggests that the sustained supply pressure from U.S. shale producers is unlikely to recede. Therefore, we will continue to see the merry-go-round of OPEC+ members trying to reduce supply to balance the supply / demand equation. The question is how long such a backstop can be sustained.
At the end of the day, it will come down to how bullish or bearish you are on the long-term outlook for oil. From the perspective of global O&G players, the focus will be on being the lowest cost producer and having resilient operations. Trying to predict where the oil price may land in 2040-50 is very difficult given the many moving parts - frankly no one saw the recent oil price movements either! What we do know is that the overall demand for oil is on a slow downward trend, but it is unlikely to totally disappear. We expect coal to give up the most ground in terms of market share, whilst Renewables to see the largest gains. Oil will still have a role to play.
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