OREANDA-NEWS. February 12, 2016. Fitch Ratings has revised the Outlook on BP plc's Long-term Issuer Default Rating (IDR) to Stable from Positive and affirmed the IDR at 'A'. A full list of rating actions is at the end of this commentary.

The Outlook revision reflects our expectation that amid weak oil prices BP's financial leverage will be higher than we previously assumed. We expect BP's funds from operations (FFO) net leverage to peak at around 3x in 2016 and to settle between 2.5x and 3x over 2017-19, in line with our guidance for the Outlook stabilisation. We lowered our price deck in January 2016 and forecast Brent to average USD45 per barrel (bbl) in 2016, gradually recovering to USD60/bbl by 2018.

The affirmation of BP's 'A' IDR reflects the company's strong business profile with diversified upstream and downstream operations, sound liquidity and the removal of uncertainty over the Macondo-related claims. In 2016-2018, BP is likely to be free cash flow negative as oil prices remain low, although the company is aiming to re-set its cost base and to balance organic sources and uses of cash by 2017. Consequently, we expect BP to increase net debt to sustain its dividend payouts in 2016-18.

BP is a leading global integrated oil and gas (O&G) company with 2015 production of 2.26 million barrels of oil equivalent per day (MMbpd) (including equity affiliates other than Russia's Rosneft) and EBITDAX (EBITDA before exploration charges) of USD20.2bn. BP's credit profile significantly improved in July 2015 following the preliminary agreement with the US Justice Department and five US states to settle the Macondo-related claims for USD18.7bn, payable over 18 years.

Weak Oil Prices
In 2015, BP's EBITDAX decreased by 32% yoy to USD20.2bn as Brent collapsed by 47% to USD53/bbl in 2015. We expect the company's 2016 EBITDAX to drop further on lower oil prices and expected weaker refining margins before starting to recover in 2017. On the other hand, we assume that cost deflation and opex rationalisation will support BP's operating cash flows in the depressed oil price environment. This includes renegotiations with suppliers and service providers, significant announced headcount reduction in upstream and other similar cost-saving measures.

In 2016, BP announced its plans to reduce capex to USD17bn-USD19bn in 2016-17, from USD22.5bn in 2014 and USD20.2bn in 2015. However, the company has also reiterated its position on sustaining dividends as its financial priority. We believe that this will force BP to increase its net debt as oil prices remain low.

Global O&G Super-Major
We view BP's operational profile as strong. Although BP has undergone selective disposals in upstream and downstream since 2011, it remains a leading global integrated O&G producer. Its 9M15 upstream production of 2.2MMbpd (including equity affiliates other than Rosneft) was trailing that of Royal Dutch Shell (AA/Rating Watch Negative, 2.9MMbpd), but ahead of Total SA's (AA-/Stable, 1.8MMbpd). At end-2014, its diversified proved reserves of 9.3bn barrels of oil equivalent (boe) (excluding equity affiliates) implied a healthy proved reserve life of 13 years, ahead of that of many peers. While the end-2015 reserves are likely to be lower on weaker oil and gas prices, their size and BP's strong upstream project pipeline should maintain the company's position in the global lead table.

Macondo Settlement Credit Positive
The USD18.7bn preliminary agreement announced in July 2015 settles the vast majority of legal claims related to the Deepwater Horizon oil spill (Macondo) in the Gulf of Mexico, including the Clean Water Act penalty and Five Gulf States claims. The deal remains subject to a final court approval, which is expected in March 2016. The payments will be spread over 18 years, with around USD1.1bn to be paid a year, ie, a reasonable outflow assuming roughly USD18bn in pre-capex cash flow from operations that we expect the company to generate per year in 2016-19. The settlement gives BP considerable flexibility to navigate the current price downturn.

Competition, Prices Threaten Disposals
We view positively the company's ability to raise cash through disposals when needed. BP raised USD48bn in disposals through October 2013, and expects additional USD3bn-USD5bn of divestments in 2016 and USD2bn-USD3bn in 2017 and thereafter.

However, too many disposals may weaken BP operationally, especially if proceeds are paid out as dividends rather than re-invested or used to reduce debt. In addition, with many O&G companies trying to divest their assets simultaneously there is a risk that assets will not be sold, or will fetch far lower prices than hoped for. We conservatively assume that BP's net disposal proceeds will reach USD3bn in 2016, ie, mainly proceeds from asset sales already agreed, and USD2bn in 2017 and USD1bn from then on.

Rosneft's Dividends Included
When rating O&G companies, we generally focus on production from consolidated subsidiaries because cash flows generated by equity affiliates may not be readily available to service debt at the parent company's level. In our forecasts, we assume that BP will continue receiving dividends from Rosneft, in which it holds 19.75%, although the amount of dividends sharply decreased in 2015 and should broadly correlate with oil prices thereafter.

Rosneft paid out RUB87bn (USD1.42bn) in dividends 2015, including BP's share of around USD280m, a very moderate amount compared with BP's operating cash flow. Taking into account political risks, we do not consider BP's stake in Rosneft, currently valued at around USD7.25bn, as a potential source of liquidity.

- Brent gradually recovering from USD45/bbl in 2015 to USD55 in 2017, USD60 in 2018 and USD65 in the long term
- Flat upstream production in 2016-19
- Macondo-related payments of around USD1.1bn per year
- Capex of USD17bn in 2016-17, rising to USD18bn in 2018 and USD19bn in 2019
- Operating leases (mainly rigs) capitalised at 8x multiple, bottom-of-the-cycle operating lease charges considered at 60% of 2012-14 actuals
- Dividend payout of USD6-6.7bn per year
- Dividends received from equity stakes (including the stake in Rosneft) broadly correlating with oil prices
- Net proceeds from divestments of USD3bn in 2016, USD2bn in 2017; USD1bn thereafter

Factors that may trigger positive rating action:
- FFO adjusted net leverage consistently below 2.5x through the cycle (Fitch's current base case expectations: 2.4x in 2015; 3x in 2016; between 2.5x and 3x in 2017-2018).
- Consistently higher upstream production compared to the 2015 level.
- Organic reserve replacement ratios at or above 100%.

Factors that may trigger a negative rating action:
- FFO adjusted net leverage above 3x through the cycle, due to higher than expected dividends and capex, or significantly lower oil prices.
- Falling upstream production compared to the 2015 level.
- Organic reserve replacement ratios consistently below 100%.
- Material Macondo-related cash outflows other than the agreed USD18.7bn.

At end-2015, BP had USD26.4bn in cash and equivalents. These amounts comfortably covered the company's short-term debt of USD7bn in 2015, as well as its negative free cash flow at least in 2016-17.

The rating actions are as follows:

BP plc
Long-term IDR: affirmed at 'A'; Outlook revised to Stable from Positive
Senior unsecured debt: affirmed at 'A'

BP Capital Markets
Senior unsecured debt: affirmed at 'A'

BP Capital Markets America Inc.
Senior unsecured debt: affirmed at 'A'