Energy

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

BP is paying its dividends out of debt again. This unhappy state of affairs may be on borrowed time.

The British oil major has one of the highest dividend yields among the U.K.'s biggest companies, at 6.8 percent. Investors are clearly skeptical about the group living within its means.

In the first quarter, the snapshot of its performance was ugly. True, so-called replacement cost profit -- the industry's standard measure -- was $1.5 billion, well ahead of forecasts and up from $400 million in the prior quarter. But the cash equation didn't balance. BP generated $4.4 billion of operating cash flow and spent $3.5 billion on capital expenditure (excluding acquisitions) plus $1.3 billion on the quarterly dividend. So there was a $400 million deficit. This was before factoring in payments relating to the Deepwater Horizon disaster.

Damages claims for the spill are meant to be covered by money raised from disposals. But proceeds from these were less than $300 million in the first three months of the year.

Small wonder that BP's net debt ticked up to $39 billion, leaving gearing -- net debt to capital employed -- at 28 percent, higher than at the end of last year. BP has a self-imposed 20 to 30 percent range for the measure.

Yet things aren't as bad as they look. Operating cash flow would have been higher but for a seasonal build-up of working capital. Add that back and the company comfortably generated more cash than its capex and dividend bill.

Breaking Out
BP has outperformed rival Shell since unveiling a new strategy in mid February
Source: Bloomberg

As for the shortfall in money raised from sales, that might be a timing issue too. Disposal proceeds are lumpy and BP is confident that higher receipts should land in the second half of the year. The vast bulk of the Gulf of Mexico spill claims have been dealt with.

Meanwhile, BP promises a big increase in cash from new projects that come on stream later in 2017. It sounds unusually bullish about their delivery, arguing that the benefits are practically locked in already.

If the jam tomorrow really arrives, the performance over the whole year should go some way to reassuring the dividend doubters. BP's capex bill in the quarter was consistent with its annual $15-$17 billion target, suggesting spending is under control.

All the same, BP can't control the oil price and another crude market shock would lengthen the transition to the company paying its way. The debt remains uncomfortably high and it's yet to be seen whether the self-imposed constraints on capex inflict any longer term damage on the business. While BP is approaching a turning point, it hasn't got there yet.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Hughes in London at chughes89@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net