Image Source: BP plc – IR Presentation
By Callum Turcan
On August 27, BP plc (BP) announced it was selling its entire Alaskan operations to privately held Hilcorp Alaska (an affiliate of Hilcorp Energy Company) for $5.6 billion. BP sold Hilcorp some of its Alaskan assets five years ago and both companies have had a working relationship since then. This truly marks the end of an era as BP was long a staple of Alaska’s oil & gas industry. BP operates the Prudhoe Bay oil field, one of the largest in the world, which was responsible for over half of Alaska’s oil production in 2018. Additionally, BP is a major shareholder in the company that owns the 800-mile long Trans Alaska Pipeline, the backbone of the Alaskan oil industry. This transaction represents a large part of BP’s plan to divest $10.0 billion in assets in 2019-2020. Please note that $1.6 billion of this deal is represented by earnouts and $4.0 billion is represented by near-term payables, and that BP sees the deal closing in 2020. After first entering Alaska back in 1959, BP is saying goodbye after 60 storied years.
The Deal
In 2019, BP’s net oil production in Alaska is expected to average 74,000 barrels per day, most of which comes from its 26% operated stake in the Prudhoe Bay oil field. For reference, BP produced ~3.8 million net barrels of oil equivalent per day during the second quarter of 2019. While BP’s Alaskan upstream operations tend to churn out a nice profit even in a moderate oil price environment, BP expects to quickly replace lost production by bringing new high-quality upstream developments online elsewhere in the world.
Please note that the Prudhoe Bay oil field is very mature and production is in terminal decline (at one point the field pumped out ~1.5 million barrels of oil per day but not anymore), which puts long-term pressure on BP’s cash flow generation in Alaska. Effectively, BP is front loading its expected operating cash flow streams from a mature asset as its long-term growth opportunities in Alaska are very limited.
BP has been angling to wind down its Alaskan operations for a while now. In 2018, BP swapped its entire stake in the Greater Kuparuk Area (an Alaskan upstream asset with room for upside) and the related midstream assets to ConocoPhillips (COP) in return for an additional 16.5% stake in the offshore Clair oil field in the UK, along with other considerations.
The outlook for ConocoPhillips’ Alaskan operations has become a lot brighter after the upstream super-independent located the Willow prospect in 2017. Over the past several years the firm completed a series of modest upstream projects in the state with more upstream developments expected to come online in the medium-term, like the GMT 2 endeavor, reviving the trajectory of ConocoPhillips’ Alaskan upstream volumes. ConocoPhillips expects the Willow prospect will come online in the 2020s which will keep the ball rolling in the right direction. Back in 2018, ConocoPhillips acquired Anadarko Petroleum’s Alaskan operations to grow its exposure to more promising parts of the state’s upstream oil industry. Anadarko is now owned by Occidental Petroleum Corporation (OXY).
The outlook for BP in Alaska is completely different as the Prudhoe Bay oil field has pumped out over 13 billion barrels of crude since achieving first-oil back in the 1960s, over half of the estimated 25 billion barrels of oil originally in place. While the new expected recovery rate of ~60% would imply a total recovery of 15 billion barrels of oil, please note that we are in uncharted waters here. In the North Sea, Alaska and elsewhere, old conventional fields are testing the boundaries of what the upstream can achieve as previously the rule of thumb was for recovery rates around 40%. The Prudhoe Bay oil field has surprised before, but it’s unlikely to offer some meaningful growth opportunities outside of the natural gas space (a strategy that faces problems of its own that we’ll cover in a moment).
BP doesn’t have any of its own very promising oil discoveries to capitalize on, unlike ConocoPhillips, and management wants to focus the energy giant’s attention on regions where upstream output is growing. Exploration activities can be costly and aren’t a surefire way to uncover new resources. We are supportive of this transaction and see it as enhancing our high-yield income thesis for BP along the margins by improving its balance sheet and long-term outlook.
What Happens to Alaskan LNG Now
Alaska is first and foremost an oil producer and exporter. Its natural gas production is fairly limited as there aren’t any major markets nearby to sell supplies to. Produced natural gas is often reinjected back into the oil field to maintain pressure levels and ultimately well productivity. Roughly 70% of Alaska’s natural gas production is “consumed” by oil and gas production processes according to the EIA. Considering the enormous declines in Alaska’s oil production levels, from the 1980s peak of over 2 million barrels per day down to around half a million barrels per day since 2010, it’s clear why Alaska would want to seek other forms of economic activity. The graphic down below clearly highlights the structural problems facing the state’s oil & gas industry. Note a lot of the decline is due to upstream operations at the Prudhoe Bay oil field getting long in the tooth.
Image Shown: Present day Alaskan oil production stands in the shadow of its former glory. Image Source: US EIA website
An interesting question arises with BP leaving Alaska: what will happen to the $40+ billion Alaskan LNG project? That endeavor hasn’t been sanctioned yet, but as recently as March 2019 the state-owned Alaska Gasline Development Corp announced it had reached an agreement with Exxon Mobil Corporation (XOM) and BP to help push the massive liquified natural gas project forward. With BP now out the picture, it’s hard to see that project going anywhere. We would be very surprised to see Exxon Mobil move forward with the massive endeavor without finding another entity to shoulder a good portion of the risks. FERC is expected to decide on whether to approve the project in early 2020.
The Alaska LNG development was already looking like a hard sell from a commercial standpoint. Global LNG supplies are rising with additional supply expected to come online from Australia, the US, Qatar, Russia, Canada, and elsewhere over the coming years. Furthermore, low raw energy resource prices over the past few years are unlikely to abate anytime soon, which is largely why Alaska’s state government got more involved in the endeavor in the first place (to keep interest in exporting the state’s natural gas resources alive).
Readers should note that the Alaska LNG export project would require an ~800-mile long natural gas pipeline to be built connecting natural gas produced in the North Slope (in northern Alaska) down to Anchorage (in southern Alaska). The need for such a pipeline, which would have to be specialty built to withstand Alaska’s frigid climate, drives up development costs.
While Alaska has an LNG export terminal already, the Kenai terminal (located ~60 miles away from Anchorage), that facility was built back in the 1960s and is outdated. The Kenai terminal’s source of natural gas supplies is very limited without access to gas produced in the North Slope region. When the terminal was operational (the last LNG export occurred in 2015), it received supplies from upstream operations in the Cook Inlet nearby. ConocoPhillips sold the facility to Andeavor in 2018. Andeavor is now owned by Marathon Petroleum Corporation (MPC) after the Marathon Petroleum acquired the refiner that same year. Note Alaska’s stable natural gas production in the graphic below.
Image Shown: Natural gas produced in Alaska is primarily reinjected back into the oil fields to maintain pressure and ultimately well productivity rates. Output in the state has been relatively stable over the past few decades. Image Source: US EIA website
Concluding Thoughts
We are supportive of BP’s decision to divest its Alaskan operations as the company has been successfully bringing upstream projects online on-time and on-budget all over the globe over the past few years, driving its net oil & gas production levels higher (upstream output was up 4% year-over-year in the second quarter of 2019). BP’s operational execution of late has been nothing less than stellar and the energy giant is included in our simulated High Yield Dividend Newsletter portfolio. Shares of BP yield 6.7% as of this writing.
Oil & Gas Majors Industry – BP COP CVX XOM RDS.A/RDS.B TOT
Refining Industry – HES HFC MPC PSX VLO
Independent Oil & Gas Industry – APA COG CLR DVN EOG OXY PXD
Oil & Gas Pipeline Industry – ENB ET EPD KMI MMP
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Callum Turcan does not own shares in any of the securities mentioned above. BP plc (BP) is included in Valuentum’s simulated High Yield Dividend Newsletter. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.