BP Plc’s potential $18 billion writedown underscores just how significant a turning point 2020 is becoming for the oil industry. It baldly acknowledges that the major hydrocarbon producers are sitting on oil fields that will never be developed — because the pandemic has curbed energy demand and increased the desire for renewables within the supply mix.
The British oil giant has a new chief executive officer and a new finance director and it was already trying to break with the past before the impact of the Covid-19 crisis became fully apparent. The outbreak has prompted a more radical reassessment of BP’s future role and what its assets are worth.
BP’s assumption is that the long-term price of Brent crude will be about $55 per barrel, up to 30% lower than it thought previously. Among its oil major peers, the company’s management is shifting from the bullish to the bearish group. On that basis, some fields won’t earn adequate returns, and some of the world’s fossil fuels that would have been extracted and burnt now won’t be.
It’s a moment to be compared not only with peers’ comments of late, but with the seismic revaluations the industry has inflicted on investors over the past two decades — think ConocoPhillips’s $34 billion of asset impairments in the financial crisis.
The shift partly reflects the near-term reduction in economic activity. Energy demand is driven by gross domestic product and that’s expected to be sharply lower this year and next. BP also sees the pandemic accelerating the move to cleaner forms of energy as policymakers look to restart economies using less conventional energy, pushing up the cost of emitting carbon.
Equities may have recovered from their lows on the expectation that many countries are returning to work. But oil stocks have not, and manufacturers such as Tesla Inc., squarely focused on the transition to cleaner forms of power, have sharply outperformed.
Altogether, this hopefully begins to address the economic conundrum that has hampered the energy transition: the relative competitiveness of dirty and clean energy. The higher returns from putting another dollar into the development of conventional energy assets have simply been too tempting for oil majors to allocate serious funds to renewables.
It may be some time before the returns BP makes from clean energy can compare with those from oil. Perhaps it can make a virtue of diversification, offering large business clients energy from multiple sources in a way that combines security of supply with an increased proportion of renewable provision.
For now, the immediate impact on BP of the writedowns will be to weaken its balance sheet by inflating gearing, which measures net debt as a percentage of total capital. This was 36% at the end of the first quarter (against a long-term target of 20% to 30%). How significant this is will depend on the view of the credit-rating firms. But the pressure to lower leverage will be intense. That, in turn, forces a rethink of BP’s generous dividend.
A few weeks ago, CEO Bernard Looney was unapologetic about maintaining the payout amid the pandemic, suggesting the board would wait and see how the crisis developed. The contrast between that message and the hard conclusions couldn’t be more stark.