Fitch Ratings has revised the Outlook on BP plc’s Long-Term Issuer Default Rating (IDR) to Positive from Stable and affirmed the IDR at ‘A’. The Short-Term IDR has been upgraded to ‘F1+’ from ‘F1’. A full list of rating actions is below.

The Positive Outlook reflects significant debt reduction in 2022 and our expectation that BP will ultimately move to a more conservative financial profile with net debt in the range of USD20 billion-USD25 billion from 2023. We forecast funds from operations (FFO) net leverage of 0.7x in 2022 rising to around 1.0x by 2024 based on our oil and gas price assumptions. This is well below our positive sensitivity of 1.8x and positions the company favourably compared with similar or higher rated peers. This will provide significant financial flexibility to implement the company’s strategy.

BP’s ‘A’ Long-Term IDR is supported by large scale, global operations, broad and diversified business model, a strong reserve base and strong credit metrics. The company intends to enhance the profitability of traditional hydrocarbon businesses over the medium term by focusing on high-grade, low-cost production in fewer countries and maximising its value creation. Additionally, there is a focus on diversifying the earnings streams of low carbon and energy transition businesses and seizing opportunities linked to new and evolving energy markets on the journey to net zero.

The more conservative financial structure and robust liquidity (the group will not need to access any new, external funding over the next 24 months, even under a stress scenario) led to the upgrade of the Short-Term IDR.

KEY RATING DRIVERS

Market Conditions Create Financial Flexibility: Tight hydrocarbon markets are supporting exceptionally high earnings for oil & gas companies. Fitch forecasts EBITDA for BP at around USD59 billion for 2022 (before income from associates and after treating leases as operating expense), moderating to around USD47.5 billion in 2023 and USD25.0 billion by 2025, based on Fitch’s oil and gas price assumptions. Cumulative free cash flow in our rating case for 2022 and 2023 is more than USD35 billion (most of which will be used for debt reduction and share buybacks).

Material Debt Reduction: In 2022, the company used 40% of excess cash flow for debt reduction and we estimate Fitch-adjusted net debt will have reduced to around USD37 billion at end-2022, from USD44 billion at end-2021. We forecast net debt to further drop to USD25 billion in 2023, but this will depend on management’s allocation of excess cash flow.

BP’s priorities for capital allocation are a base dividend (USD0.06006 per share for 3Q22, increasing by at least 4% annually at USD60 per barrel), a strong investment-grade credit rating, disciplined capital investment and share buybacks (in this order).

Robust Financial Profile: We forecast EBITDA net leverage at 0.6x for end-2022, rising to 1.0x by 2025, linked to Fitch’s price assumptions, which is well below our positive leverage sensitivity and supports the Positive Outlook. This should be achievable as the medium-term market outlook for oil & gas remains robust and BP should benefit from a sizeable working capital unwind over the next two years (from LNG contracts and moderating prices) and lower restricted cash in margin accounts (when market volatility reduces). Based on its strong financial profile the company is well placed compared with peers including TotalEnergies SE (AA-/Stable), Shell plc (AA-/Stable) and ConocoPhillips (A/Stable).

Strong Business Profile: BP’s business profile is underpinned by large upstream production of 2mmboe/d (2.2mmboe/d including equity affiliates), very large oil and gas reserves (proved reserve life of 9.3 years at end-2021 for consolidated operations), international asset diversification, a competitive cost position and integration into downstream, trading and marketing. BP aims to capitalise on its global reach by expanding its LNG franchise, increasing the value-added content of its hydrocarbon sales, optimising costs, broadening exposure to electricity and new energy products and bundling the offering for a growing customer base.

Windfall Taxes Circulating: BP will pay USD2.5 billion of profit tax in the UK in 2022, including USD800 million linked to the 25% uplift levy announced in May 2022. Obligations from the EU ‘solidarity payment’ are not yet quantifiable, but BP’s earnings in the EU only make up around 5% of group profits. Currently there do not seem to be any other countries where BP has upstream production considering windfall taxes, but this could change if market tightness and dislocations persist.

Transition Strategy Gaining Momentum: BP targets generating around 20% of EBITDA (USD9 billion-USD10 billion in absolute terms) from bioenergy, convenience, electric vehicle charging, renewables and hydrogen by 2030. Recent acquisitions, including the 40.5% stake in the Asian Renewable Energy Hub and Archaea Energy, add momentum to the implementation. Overall, BP has a more ambitious sustainability strategy than other integrated oil & gas majors and medium-term earnings from these businesses are clearly growing.

Financing of Energy Transition Businesses: Peak oil demand is expected to be reached in late 2020s. BP does not guide how much of its USD9 billion-USD10 billion target EBITDA for transition growth businesses will be consolidated. BP Bunge Energia, lightsource bp or the Asian Renewables Hub are all equity-accounted, with material debt deployed within those entities (already or in future). If a substantial portion of the transition target earnings has high underlying leverage through project financings (including ring-fencing provisions), these earnings may not mitigate the increasing risk profile of the hydrocarbons business. In this case, higher debt reduction and a more stringent financial profile of the group would be more commensurate with the rating.

Capital Allocation in Focus: While earnings are currently high across the oil & gas sector, balancing interests of shareholders and debt creditors and rebalancing the companies’ positions for a sustainable future will become more difficult in the longer term. Capital allocation frameworks will need to evolve and capture the changing debt capacity of major (consolidated) earnings contributors and differences in energy transition strategies.

DERIVATION SUMMARY

BP is a leading global integrated oil and gas producer with diversified assets in the upstream and downstream segments. In 2021, its production of 2.0mmboe/d (47% liquids; excluding equity affiliates) trailed that of Shell plc (3.0mmboe/d; 55% liquids), but was comparable with TotalEnergies SE (2.1mmboe/d; 62% liquids). BP’s upstream assets are well-diversified geographically, with around half of the group’s production located in highly rated countries.

BP has strong downstream operations (refining, retail and lubricants) and is a major global LNG player. Its financial leverage towards the end of the forecast horizon is incrementally higher than its principal peers at EBITDA net leverage of around 1x; for Shell and TotalEnergies’ long-term leverage expectations range around 0.5-0.7x. All three companies have used exceptional cash flow generation in the prevailing market to reduce net debt to very low levels.

TotalEnergies is ahead with renewables installed capacity of 5.1GW (BP 1.9GW), total electricity generation from renewables and gas of 21.2 TWh and 25,734 electric vehicle charging points (BP 13,000). In turn, TotalEnergies has proportionately lower refined product sales and lower utilisation rates for its refining capacity. BP targets reducing upstream oil & gas production to 1.5mmboe/d (equity and affiliates) by 2030, while TotalEnergies is still expanding hydrocarbon production volumes with an effort to increase the gas share, which would then be more in line with BP later in the decade. As a result, BP will make more progress towards absolute carbon abatement within its business by 2030 and earnings contributions from lower carbon and energy transition businesses will gain in relative importance sooner for BP.

ConocoPhillips is the largest independent exploration & production company in North America with 1.5mmboe/d consolidated production (73% liquids; 1.75mmboe/d including affiliates). The group has meaningful country diversification of upstream production, in jurisdictions with relatively stronger operating environments, a low-cost resource base (economic to develop at less than USD30/barrel) and conservative financial policies. Its net leverage is broadly in line with Shell and TotalEnergies, but gross leverage is significantly lower, given that US producers tend to hold much lower cash balances.

ConocoPhillips lacks the mid-stream and downstream integration/diversification that allow Shell, BP and TotalEnergies to reduce earnings volatility through the cycle. As a focused exploration & production company, ConocoPhillips does not have any material scope 3 emission reduction targets (apart from its Canadian operations, which represent 160,000 boe/d, less than 10% of the business) and lacks future earnings diversification into energy transition businesses.

Source: Fitch Rating