Monday, June 10, 2013

BP: The Good, the Bad and the Ugly

From The Motley Fool, Date May 30, 2013
The European oil major BP (NYSE: BP) recently released its quarterly results. The performance follows the mammoth deal with Russian oil giant Rosneft, which is the seventh-largest holding in the Market Vector Russia ETF (NYSEMKT: RSX) and the ninth-largest in the iShares MSCI Russia Capped Index Fund (NYSEMKT: ERUS). However, the ghosts from the Gulf of Mexico oil spill continue to haunt BP’s investors. Let's take a look at the ETFs first.
The Market Vectors Russia ETF is the leading Russian capped ETF with total net assets of $1.5 billion. Its biggest holding is the oil giant Lukoil, which represents 8.6% of its net assets and it generates a yield of 2.6%.
On the other hand, the iShares MSCI Russia Capped Index Fund has total net assets of just $212 million, but is heavily focused on Lukoil, which represents 17% of the total net assets, and generates a yield of 2.5%. Naturally, since the country both ETFs represent is the biggest producer of crude oil, both ETFs are energy-focused and allocate more than 40% of their funds to this sector.
Generally, these ETFs are the ones to avoid during a slump in oil prices, so the recent recovery of crude to $95 per barrel caused a massive net inflow of $400 million in the first two weeks of May into the Market Vector Russia ETF. Russia's energy sector has not really delivered a stellar performance. But, as explained later in the article, the leading energy firms are moving in the right direction, and the country has a low unemployment rate and high capacity utilization; therefore I am more optimistic about the long-term prospects of the two funds.  
The Rosneft deal
In March, BP and Rosneft closed their $55 billion TNK-BP deal. Accordingly, BP sold its 50% stake in TNK-BP for $16.7 billion in cash and a 12.5% stake in Rosneft to a holding of 19.7%, making it the second-largest shareholder in the company. BP plans to return some of the cash infusion to its shareholders (more on this later). Subsequently, Rosneft has become the world’s biggest listed oil and gas firm in terms of production and reserves, ahead of ExxonMobil. The behemoth will now produce 40% of Russia's oil output, or around 5% of the global production.
The earnings
BP earlier announced its earnings for the first quarter of 2013. Its net income trebled to approximately $16.9 billion from about $5.8 billion a year ago due to the $12.5 billion gain from the TNK-BP sale. Excluding that, the business was still able to beat analysts’ estimates as the adjusted earnings fell by 9.4% from the same quarter last year to $4.2 billion -- which is considerably above analysts’ expectations of $3.3 billion.
Revenue rose 10% to $107.2 billion. The upstream profit fell around 9.5% to $5.7 billion and production dropped by 5% to 2.3 million boe/d – which is inline with estimates. Downstream profit climbed to $1.3 billion from just $490 million a year ago due to better fuel trading.
The oil spill
Following the Gulf of Mexico oil spill,  BP is now preparing for a costly encounter comprised ofmore than  2,200 new lawsuits with individuals, corporations and government bodies as the April 2014 deadline for filing claims approaches. Patrick Juneau, the payout administrator, thinks that more than 200,000 claims will be filed by the last date.
In the disaster, 11 people lost their lives as 4.9 million barrels of oil flowed out into the ocean from BP’s underwater well. Subsequently, in June 2010, the company announced a $20 billion compensation fund for spill victims and promised incentives to discourage any future lawsuits. So far, out of the $20 billion, just about $1.7 billion is unassigned.
Overall, BP estimates it will spend a total of $36.5 billion on fines, settlements and cleanup costs. It has already paid around $24 billion, while the remaining balance will be paid in the coming years. The silver lining here is that the $4 billion settlement with the New Orleans district court has put an end to all federal criminal charges.
Overall, I believe BP has delivered a strong operational performance. The Rosneft deal has not only taken BP out from the politically challenging TNK-BP but has also given it a position at Rosneft’s board.
Bullish on Rosneft
Rosneft currently has financing issues and generally has a tough time finding lenders. But it is making the right moves by approaching the energy-starved nation China through CNPC and China Development Bank. Russia has lots of oil and Rosneft is the biggest player there. To get a perspective on its size, imagine a company that will produce more oil than Canada or Iraq – that is Rosneft.
In its recent quarterly release, the company reported a 12.8% drop in profits to approximately $3.3 billion – mainly due to the acquisition-related costs and foreign exchange losses. Its total output was 4.8 million boe/d, which includes 0.6% organic growth. Therefore, I am long-term bullish on Rosneft and the two energy focused ETFs mentioned above.
BP: Looming threats
However, for BP, I believe that the benefits resulting from its deeper integration into Russia and the possibility of getting the Russian Arctic oil exploration rights cannot offset the looming threats coming from the oil spill. Under the Clean Water Act, BP could be slapped with a maximum fine of $21 billion. Although it is highly unlikely that the company will have to pay the full amount, it does create a lot of pressure on its balance sheet. While BP won’t face any more criminal fines from the U.S government, the door to civil penalties is still open.
The company has failed to give a proper estimate for business and economic losses (BEL) related to the spill, which have now climbed to $8.2 billion as opposed to its previous estimate of $7.8 billion. As mentioned earlier, BP has now $1.7 billion left out of the total $20 billion it set aside. If the actual amount exceeds  that, or if the payments continue at their current rate, then BP will start charging these expenses directly to its bottom line.
BP: The takeaway
If the oil spill charges continue to grow at their present rate, then BP’s quarterly profits will be directly hit. And this could happen as early as next year. BP could also decide to hold onto its cash reserves until the extent of potential fines is clearer, which would could mean delaying the $8 billion buyback program. Either way, it would be bad news for the shareholders.
The markets, including myself, are still not convinced about the buyback program, which is the reason that the share price didn't appreciate when it was announced. Therefore, despite the positive results and the Rosneft deal, I believe that BP is not a ‘Buy’ at the moment. 
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own personal opinion. I have no business relationship with any company whose stock is mentioned in this article.