Fitch: BP/BHP Deal Presents Growth and Cash-Return Balancing Act

(The following statement was released by the rating agency) Fitch Ratings-London-July 30: Last week's announcement that BHP has entered into agreements with BP and Merit Energy to divest its US shale oil and gas assets highlights how global energy companies are positioning for long-term growth while returning more cash to shareholders, Fitch Ratings says. Buybacks and dividends are increasing amid recently recovered oil prices, while asset portfolios are being managed to raise production and replenish reserves after years of subdued investment. BHP intends to return the transaction net proceeds to shareholders, USD10.5 billion from BP and USD0.3 billion from Merit Energy. The announcement follows a campaign by activist investor Elliott Management to unlock value and improve capital returns to shareholders by separating BHP's US petroleum business and increasing share repurchases. Activist campaigns are typically negative for creditors if they result in increased distributions to shareholders, or less diversification. The deal has no immediate rating implications for BHP (A+/Negative) or BP plc (LON:BP) (A/Stable), and BHP's Negative Outlook already reflects the likely disposal of onshore oil assets, which has been a possibility for some time. We expect the divestment to reduce the earnings contribution and diversification provided by BHP's petroleum assets. Fitch's downgrade sensitivities for BHP include weaker operating performance, large debt-funded acquisitions, or increased shareholder returns resulting in FFO adjusted gross leverage sustained above 1.5x. Rating actions will also be influenced by the company's future production targets for its remaining petroleum assets and medium-term capital investment. BP, which is purchasing the majority of BHP's onshore oil and gas assets, says the deal is consistent with its strategy to strengthen its position in the US. We expect BP's upstream production (excluding equity affiliates) to increase by 8%, and its EBITDA to increase by around 5% compared with our previous forecasts for 2018. Most major oil and gas companies see upside potential in US shale, with Exxon (NYSE:XOM), Chevron (NYSE:CVX), Shell (LON:RDSa) and now BP announcing accelerated investment and acquisitions this year. Total, which completed its acquisition of Danish oil and gas company Maersk Oil in March, has avoided investments in US shale due to its view that shale assets are too expensive. We believe Total could eventually change its opinion given competitive pressure and shale's shorter investment cycle, which is an advantage during periods of high price volatility. BP plans to finance the acquisition through a combination of cash and equity. We expect its leverage to increase slightly compared with our previous forecasts and to remain within our guidelines for the rating. The deal addresses BP's underinvestment over the past few years and we expect it to improve the company's business profile. BP also announced that it will raise its dividend for the first time in 15 quarters, by 2.5%, and plans share buybacks up to USD5-6 billion over the next few years, on top of buybacks aimed at offsetting the scrip dividend. Additional buybacks are to be funded by asset disposals. Like BP, Shell and Total also intend to return more cash to shareholders. Shell has discontinued its scrip dividend and launched a long-promised USD25 billion share buyback programme - the main reason for the Negative Outlook on its 'AA-' rating. Total (AA-/Stable) plans a dividend increase of 10% over 2018-2020 and a share buyback up to USD5 billion (in addition to shares being bought back to eliminate the dilution effect from the scrip option). We believe Total has the capacity to deliver on this without compromising its rating. Higher payouts to shareholders are the result of executives' confidence in future business prospects as big oil companies have reset their cost bases and oil prices are much higher than anticipated just half a year ago. However, higher payouts may also be symptomatic of growing investor pressure, and could jeopardise credit quality if oil prices weaken substantially. We currently rate oil companies assuming Brent prices falling from USD70/bbl in 2018 to USD57.5/bbl by 2020. Contact: Dmitry Marinchenko Director, Corporates +44 20 3530 1056 Fitch Ratings Limited 30 North Colonnade London E14 5GN Slava Demchenko Associate Director, Corporates +7 495 956 2407 Oliver Schuh Director, Corporates +44 20 3530 1263 Carla Norfleet Taylor, CFA Senior Analyst, Fitch Wire +1 312 368-3195 The above article originally appeared as a post on the Fitch Wire credit market commentary page. 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