Can BP Ever Fix Its Ailing Downstream Business?

As part of its push to improve its financial performance and boost shareholder returns, BP is looking to restructure its refining operations in places like Australia and Europe, where refining margins are especially weak. Let's take a closer look at whether or not the company's moves will pay off.

A BP retail gasoline station. Photo credit: Wikimedia Commons

BP to cease operations at Queensland refinery
BP recently said that it plans to stop operations at its 102,000 barrel-per-day Bulwer Island oil refinery in Queensland, Australia, by the middle of next year due to extremely weak refining margins. The British oil giant said it is thinking about converting the Bulwer Island refinery, which has been operating for more than four decades, into a fuel-import terminal.

The move doesn't come as much of a surprise, given the numerous challenges facing Australian refineries. These include growing competition from newer, more efficient refineries in Asia, a strong local currency, and more stringent fuel-quality standards, all of which have contributed to lower Australian refining margins.

That leaves companies with two options: selling the refineries outright or converting them into fuel-import terminals, as BP plans to do. Royal Dutch Shell , on the other hand, recently took the first route and agreed to sell its Geelong refinery and its roughly 900 retail gasoline stations in Australia for $2.6 billion to commodity trading house Vitol.

The Anglo-Dutch oil major has identified its downstream business as one of two key businesses that will he heavily restructured in the next few years in order to improve its financial performance and boost shareholder returns.

Will the move pay off for BP?
All else being equal, BP's decision to close its Bulwer refinery should help modestly improve its overall refining margins since it should lower the company's average refining costs per unit. Combined with other measures BP has taken to boost its downstream performance over the past few years, this could help its downstream unit return to profitability over time.

These measures have included the sale of several refineries in Europe, as well as the sale of its Carson, Calif., refinery last year. BP has also carried out major upgrades at two refineries in Cherry Point, Wash., and Toledo, Ohio, as well as a major modernization program at its Whiting refinery in Indiana, which will boost the facility's margins by allowing it to process greater volumes of cheaper heavy, sour crude.

Indeed, profitability at Whiting has already improved substantially and BP expects the refinery to generate $1 billion of cash flow this year. Combined with six major high-margin oil project start-ups this year in the Gulf of Mexico, the UK North Sea, Canada's oil sands, Azerbaijan, and Angola, this should help the company generate $30-$31 billion in operating cash flow this year, which should easily cover its expected capital expenditures of $24-$25 billion and dividend payments.

BP also plans to unload an additional $10 billion worth of assets this year and next, having already sold some $38 billion worth of assets over the past few years. The combination of these asset sales and stronger than expected cash flow should allow BP to return more cash to shareholders in the coming years through share buybacks and dividend increases.

Risks and uncertainties remain
But despite reasons to be optimistic about BP's future, major risks and uncertainties remain. Most pressing is BP's heavy exposure to geopolitical risk in Russia through its 20% stake in state-owned Rosneft. The possibility of Russia expropriating BP's stake remains a worrying possibility, especially if Russian relations with the U.S. and Europe deteriorate further.

Another major uncertainty is potential federal Clean Water Act penalties the company could face for its involvement in the 2010 Gulf of Mexico oil spill. If the company is charged with gross negligence and charged the maximum fines possible, it would add billions of dollars to its spill tab and likely force an asset fire sale. Investors would be wise to consider these risks before investing in BP.

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Arjun Sreekumar has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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