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Why Are BP’s Cash Reserves Plunging?

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BP’s cash flow from operations, investing, and financing

In 1Q16, BP’s (BP) cash flow from operations stood at $1.9 billion, almost the same level as in 1Q15. BP’s cash outflow from investing stood at $3.2 billion in 1Q16 compared to $3 billion in 1Q15.

BP’s cash flow from financing activities mainly consisted of changing debt levels and dividend payments. BP focuses on providing returns to shareholders in the form of dividends. BP’s current dividend yield stands at 7.5%. BP’s peer ExxonMobil’s (XOM) dividend yield stands at 3.3%.

Comparatively, Chevron (CVX) and Royal Dutch Shell (RDS.A) have higher dividend yields of 4.3% and 7.4%, respectively.

If you’re looking for exposure to high-dividend stocks, you can consider the iShares Core High Dividend ETF (HDV). The ETF also has ~21% exposure to energy sector stocks.

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Analyzing BP’s cash flow strategy

In 1Q16, BP generated $1.9 billion in cash from operations after deducting Gulf of Mexico oil spill charges worth $1.1 billion. However, the company had cash outflows of $4.3 billion in capital expenditure, $1 billion in dividends, and $0.9 billion in net debt repayments, amounting to total of $6.2 billion.

How did BP make up the difference in cash flows?

Due to lower cash flow from operations due to oil spill charges and lower oil prices, the company had to utilize its cash balance and resort to asset sales. BP executed asset sales to the tune of $1.1 billion in 1Q16. The remaining shortfall was mainly funded by drawing down its cash reserves.

For how long can this strategy be maintained?

BP cannot perpetually utilize its cash reserves. If oil prices remain subdued for an extended period and oil spill charges continue to be a burden, BP will have to boost its leverage, cut its capital expenditure or dividends, or adopt a mix of these strategies.

As pointed out in the previous article, ascertaining the right leverage level will be imperative for the company to maintain its financial strength and flexibility.

Going forward, higher production will likely improve cash flow from operations, but the degree of the improvement will mainly depend on oil price levels and further oil spill charges.

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