Spill Deal a Winner for BP

By Robert Rapier • July 8, 2015 • Energy Strategist Weekly

At the start of the year, I predicted that BP (NYSE: BP) would be bought out or merged in 2015. I consider this the most aggressive of my annual predictions this year, primarily because my time frame is limited to 2015.

But one major roadblock to an outside bid was lifted last week as BP settled with the U.S. federal and state governments its liabilities stemming from the 2010 Deepwater Horizon oil spill.

Eleven workers were killed in that accident, and an estimated 4 million barrels of oil were spilled into the Gulf of Mexico. After BP agreed to pay $18.7 billion over 18 years to settle the federal and state claims and fines, its tab for the disaster rose to nearly $54 billion.

Under the deal, BP will:

  • pay the U.S. a civil penalty of $5.5 billion under the Clean Water Act (CWA) over 15 years

  • pay $7.1 billion to the U.S. and the five Gulf states over 15 years for natural resource damages (NRD). This is in addition to the $1 billion already committed for early restoration. BP will also set aside $232 million to be added to the NRD interest payment to cover natural resource damages that are presently unknown

  • pay $4.9 billion over 18 years to settle economic and other claims made by the five Gulf Coast states

  • pay up to $1 billion to resolve claims made by more than 400 local government entities.

BP shares jumped more than 5% Friday  on the news, because investors had been expecting a fine of as much as $17.6 billion under CWA alone. This amounted to about 10% of BP’s market capitalization as of a week ago, so it isn’t surprising that shares would jump in response to a much smaller fine spread over 15 years.

This also removes a great deal of the uncertainty hanging over BP, which was one of the single biggest barriers to being taken over (although there are still plenty of outstanding private legal claims against BP).

Although the Gulf spill has now consumed all of its profits since 2012, BP remains one of the world’s few publicly traded supermajor oil companies. A snapshot from the corporate website provides a glimpse into the breadth and depth of its operations:

150708TELbp
BP’s share price is still about 30% below its level just before the spill. Therein lies the appeal. As a result of the long-term decline, BP’s oil and gas reserves are valued far below those of the other supermajors per unit of energy, and the share price trades at a discount to larger rivals like ExxonMobil (NYSE: XOM) and Chevron (NYSE: CVX). I emphasized that point strongly in a presentation I gave in May at Investing Daily’s annual conference in Denver:

150708TELbp2
EV = Enterprise Value in billions of dollars as of April 21, 2015
Reserves = Proved reserves in billion barrels of oil equivalents (BOE) at year-end 2014
Production = 2014 daily production in million BOE per day
RoA = Return on Assets
CR = Current assets for the most recent quarter divided by current liabilities for the same period

The 3.2 million barrels of oil equivalent (BOE) produced daily by BP in 2014 wasn’t that far behind ExxonMobil’s 4 million BOE per day. Its 17.5 billion BOE of oil reserves at the end of 2014 amounts to 69% of ExxonMobil’s 25.3 billion barrels, yet BP’s enterprise value is only 39% of Exxon Mobil’s. (While the EV is from April, there has been little change in the price of these supermajors, so these numbers are still pretty accurate.)   

Note the EV/Reserves number for BP versus the other supermajors. Of course this is not an absolute apples-to-apples comparison, because each of these companies has businesses beyond oil and gas production. For instance, BP has substantial refining assets and a huge trading group for oil and gas. But even if you valued those businesses at zero, the value of BP’s reserves is ridiculously low at $8.51/BOE.

Several sources have reported that before Shell (NYSE: RDS-A) announced its $70 billion acquisition of BG Group (London: BG), it seriously considered bidding for BP. Shell is likely out of the picture now as it attempts to digest its new acquisition, but a recent Bloomberg story claimed “BP executives are concerned the company is vulnerable to an opportunistic bid” — with ExxonMobil and Chevron mentioned as the most plausible pursuers. BP has reportedly stepped up internal reviews of takeover scenarios and simulations of defense strategies against a hostile takeover, but the company would have limited options if ExxonMobil came knocking.

In my view Chevron is the best fit for a number of reasons (some of which I have detailed in previous articles in The Energy Strategist.).

Any such a deal would likely be opposed by some in the U.S. government, but even more so by the British government. BP has a long, proud history as a UK company, and the British government isn’t anxious to let its assets fall under control of executives in Houston. Still, the government is unlikely to be able to stop a determined suitor.

The potential payoff is clear. An oil major exploring expensively for oil and gas can find some low-cost reserves right on BP’s balance sheet. For Chevron, these reserves could probably be acquired for around half the value of the reserves currently on Chevron’s books.

As we advised in The Energy Strategist back in April, “today’s price will probably prove to be a bargain for those with the risk tolerance and the patience to persevere until either BP’s legal challenges are behind them, or a competitor steps up to make a bid.”

BP continues to be one of the most discussed companies in The Energy Strategist. Sign up today to get our current recommendation on the stock, as well as a look at the three portfolios that have consistently beaten their respective market indices over the past two years.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Another Crude Storm Brewing

Crude oil bounced a bit Tuesday in the wake of Monday’s plunge of nearly 8%, but odds still favor lower prices in the near term. U.S. production has merely plateaued near the recent longtime highs, while nuclear negotiations with Iran are in the final stretch and could result in a big increase of supply from that country. Meanwhile, China’s stock market and economy are ailing, representing a significant risk to optimistic projections of rising global demand.

So we’re back to lightening up on stocks particularly leveraged to crude output and prices. Today that means recommending the sale of fracking sand miner Hi Crush Partners (NYSE: HCLP) as well as shale drillers Clayton Williams Energy (NYSE: CWEI), Jones Energy (NYSE: JONE) and Bonanza Creek Energy (NYSE: BCEI).

There is nothing wrong with any of these names that $75 crude wouldn’t cure. Unfortunately, that price is not in the offing this year given the fundamentals of global demand and supply.

Our portfolios continue to favor the midstream and downstream sectors that should keep performing amid low oil prices. The refiners and midstream processors are benefiting from the growing U.S. demand for energy while taking market share from the higher-cost rivals overseas.

Drillers will have their day in the sun again, but owning them until it comes around again could prove costly. Sell HCLP, CWEI, JONE and BCEI.

— Igor Greenwald


     

     


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