BP has made meaningful and necessary efforts to improve the safety of its equipment and employees.
However, given that the largest new oil fields being discovered are in deep offshore, and that ultra deepwater production is expected to be the fastest growing source of oil in the coming decades (according to Rystad Energy, an oil & gas consulting firm), there is always the risk that BP will eventually revert to its more lackadaisical safety systems.
The second major threat to BP, and especially its dividend, is of course the unpredictable nature of oil prices.
As you can see below, the world has been in a massive supply glut of crude for several years now. This has resulted in record high inventories of oil that, even once demand begins to outstrip supply, will take years to work off.
In fact, even if long-term demand outstrips supply by one million barrels per day, it would take about 8.5 years to work off the current inventories in developed nations alone.
That isn’t to say that oil prices will languish at $50 per barrel or so for all of that time. After all, oil prices are largely based on futures markets, which are forward looking. Prices could jump past $60 if the current glut becomes a large enough deficit.
However, there is a major wildcard in the mix, one that has bedeviled all attempts to predict when the crash would end – US shale producers.
Shale producers both big and small have made amazing strides at using new drilling techniques. These include using horizontal drilling, longer laterals, multiple frack stages, and as much as 20,000 tons of frack sand per well to increase production and lower costs.
This is largely why, with oil now at $50 per barrel, we’re seeing the number of US drilling rigs climbing in eight of the past 10 weeks. In other words, the risk is that US oil companies have become so efficient that they can profitably produce oil at even today’s prices.
With over 3,900 drilled but uncompleted wells, mostly in US shale formations such as the massive, prolific, and low cost Permian basin, US oil production could literally increase seemingly overnight. There is also a large amount of oil sitting offshore in storage tankers.
This helps explain why oil prices haven’t soared more on the long awaited agreement by OPEC to finally cut production.
The markets know that OPEC members are notorious for cheating on their quotas, and even if the Cartel can make members toe the line on production, there is a very real chance that US shale production could quickly step in to offset any declines in OPEC production.
In other words, the long and painful oil war Saudi Arabia began over two years ago in order to regain market share may end up failing completely but with oil prices at half their previous level. US shale producers could continue gaining much greater control of the oil market in the years to come.
Unfortunately for BP, it doesn’t have the ability to stop producing oil in many areas where its cost of production exceeds the current price of oil.
Traditionally, U.S. and Western Europe oil and gas companies explored locally. Once all the local supply was used up, they had to turn to oil-rich countries around the world to continue growing.
Many of these foreign countries do not have the technological know-how or expertise to pull the oil up themselves, but they are able to extract lucrative deals by partnering with Western oil companies.
These contracts usually require Western oil companies to produce a daily quota of barrels and pay the country a certain price per barrel that may have little direct or immediate relation to the prevailing market price of oil.
Even when the price of oil drops, the Western companies still have to produce the amount agreed to under contract. The host country gets paid first and the price agreements may continue to cause losses for the foreign partners regardless of an increase in market pricing.
In other words, to get comfortable investing in a major oil company like Exxon or BP, an investor needs to be aware that it’s not just the cost of production in each part of the world, but the contracts and sunk costs each company has.
