BP Returns To Growth

Jan. 7.14 | About: BP p.l.c. (BP)

Gulf of Mexico: Continues to be the basis of growth

BP plc. (NYSE:BP) along with ConocoPhillips (NYSE:COP) recently discovered an oil reservoir in the Gulf of Mexico. This discovery was made in the Gila prospect, which is about 300 miles southwest of New Orleans at a depth of around 4,900 feet. The depth of drilling is approximately 29,000 feet. This is the third reservoir discovery by BP and fourth reservoir for ConocoPhillips in the Paleogene system, also known as Lower Tertiary as well as the lower tertiary fields. BP owns around 80% of the Gila field, with ConocoPhillips owning the rest.

BP's two other deepwater reservoirs in the Gulf of Mexico are Kaskida (with around 3 billion barrels of oil reserves in place) and Tiber (estimated to have 4 billion to 6 billion barrels of oil in place). Oil reservoirs such as these are important for BP to continue its production growth and replace depleting resources. BP will assess the resource potential of the Gila reservoirs in the coming quarters. The cost per well is in the range of $100 million and an additional $1 million per day to operate. BP plans to spend around $4 billion a year in the Gulf of Mexico over the next decade. In spending around $4 billion, I expect that BP could drill around 40 wells in the region in 2014. This amount of spending in its Gulf of Mexico exploration program will enable BP to develop its acreage there.

BP continues to strengthen its position in the Gulf of Mexico in other ways as well. It is the leading leaseholder and oil producer in the region and has nine rigs operating there. The Lower Tertiary field where the Gila reservoir was discovered is expected to contain around 15 billion barrels of oil. Other explorers in this formation are Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), and Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B). To successfully drill at pressures of around 20,000 psi, BP initiated Project 20K. This program will develop new designs of rigs, risers, and blowout preventers that will operate at a pressure of 20,000 psi. Currently, the oil-and-gas drilling industry's capacity is to drill at depths with pressures of around 15,000 psi. The successful outcome of Project 20K is more likely to help BP drill safely at huge depths such as in Gila and similar reservoirs in the Gulf of Mexico.

Pushing in the Middle East

BP entered an agreement with the government of the Sultanate of Oman in December for gas sales and the full field development of the Khazzan field. The full field development will include drilling of around 300 wells with a peak production capacity of around 1 billion cubic feet per day, or bcfpd, and 25,000 barrels per day of gas condensate. This development project is a joint venture between BP (60%) and Oman Oil Company Exploration & Production, or OOCEP (40%), with total spending of around $16 billion. Development of the field will start in 2014, with the first gas production to begin in late 2017. In the joint venture BP will use technology to extract tight gas from the Khazzan field. The project is expected to develop around 7 trillion cubic feet, or tcf, of gas. The Khazzan is one of the most challenging oil-and-gas fields in Oman with well depths reaching 15,000 feet. BP has been working in the Khazzan field, having already invested around $1.5 billion there.

Price is important in developing a tight gas formation. While the government plans to increase gas prices, the gas price at which the BP's deal is made is undisclosed. In Oman, the natural-gas price for industrial customers is expected to increase to around $3 per million British thermal unit, or mbtu, by 2015 from around 1.5 per mbtu in 2012, as the Omani government plans to reduce the natural-gas subsidy. Over the life of the project of 15 years, BP plans to develop around 7 trillion cubic feet, or tcf of gas. At a conservative assumption of a natural-gas price of $3 per mbtu, 7 tcf of gas would be valued at $21.11 trillion. This amount of gas production is likely to add significant value for BP in the coming quarters.

Demand will largely determine natural-gas development in Oman. Use of natural gas has been on the rise. Natural-gas usage for industrial projects in Oman during the first half of 2013 was around 56% of Oman's total natural-gas consumption, which grew by around 5.1% during the first half of 2013 to 19,308 million cubic meters. The increasing domestic consumption of natural gas within the country has been met by reducing exports. Increased consumption remains one of the main drivers in the growth of natural-gas production and investment into tight gas technologies.

Bold steps into the future

BP has been true to its objective of increasing production reserve. In 2012, BP had a replacement ratio of 77%, meaning the company replaced less than the depletion of its oil-and-gas reserve. Generally an oil company aims for a replacement ratio of more than 100%. The company's discovery of the Gila field and development of the Khazzan field is a step to improve its replacement ratio. BP's focus to maintain its leading position in the Gulf of Mexico will give the company an advantage over the other oil companies in the region. Further, to help in the ongoing exploration in the Gulf of Mexico, BP has committed to the development of technology that will enable such future exploration. With large reserve potential and technological advancements BP is likely to maintain its lead in Gulf of Mexico deepwater drilling.

BP is also introducing tight gas technologies into the Khazzan fields of Oman. Having huge reserve potential, this field is likely to boost the production output of natural gas in Oman and also of BP, but natural-gas demand remains strong in Oman. The price of gas is critical for the success and longevity of tight gas projects, and recent pricing decisions of natural gas by the government in Oman is likely to lend a conducive environment in the coming quarters.

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 opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.