BP plc: Investments In Russian Energy Seem Worth The Risk

Compromise is the reasonable expectation for imminent resolution of the dispute between the Russian government and buy-recommended BP plc (BP) over the rights to a natural gas field in Eastern Siberia. With reserves of seventy trillion cubic feet worth over a half a trillion dollars in revenue at today’s futures prices, there is enough resource value to benefit all parties.

BP has little to lose since all the company’s Russian natural gas reserves account for 1% of estimated net present value [NPV] of $87 a share. President Putin appears to have two objectives, first to prevent BP’s selling the gas to China for a cheap price as is apparently the case with BP’s Tangguh Indonesian LNG project, and second to reclaim some of the public resource value that moved into the hands of a few oligarchs under murky circumstances during the chaotic years of the Yeltsin era.

Publicity over the current controversy may have contributed to less investor confidence not only in BP, but also in our buy-recommendations of Gazprom (OGZPY.PK) and Lukoil (LUKOY.PK). We believe investments in Russian oil and gas are potentially among the most rewarding along with the risk of possibly disturbing political developments.

Retrieving the Crown Jewels

BP had Putin’s approval, we understand, when it acquired 50% of TNK-BP, the company through which BP participates in Russia. Through that venture, BP has the rights to a third of Kovykta. Owners of the other half of TNK-BP, including prominent oligarchs, also account for a third. Other owners, unknown to us, hold the remaining third of the rights to the half-trillion dollar resource.

Possible compromise includes selling a portion, perhaps half, of the whole field to the government, or to Gazprom, 50% owned by the government. In addition, Russian owners may be encouraged to sell direct interests in Kovykta to the government and/or sell shares of TNK-BP to the government or to a government company.

Precedent in Hugoton and Groningen

By size of the natural gas resource, Kovykta matches Hugoton (HGT) and Groningen, the two earliest clean fuel giants of the U.S. and Europe. With price controls, the U.S. government virtually confiscated the economic value of Hugoton. The mistake was eventually rectified when controls were finally lifted in about 1990.

Russia can learn from our errors.

In contrast, since about 1960, the Dutch government allowed Royal Dutch/Shell (RDS.A) and Exxon (XOM) to make profits from Groningen that strengthened the companies immeasurably for more than the next four decades. Those two companies went on to make large natural gas discoveries in the southern North Sea and became leaders in the exploration of a whole new offshore petroleum province that benefited all of Europe.

In the wake of an earlier dispute over another giant Russian natural gas field, Jeroen van der Veer, chief executive of buy-recommended Royal Dutch Shell, credits Russian President Putin for his help in arriving at a compromise, according to the Financial Times. Settling the Sakhalin Saga, Shell and its partners sold a half interest in the Far East natural gas project to Gazprom. Mr. van der Veer told Dutch television that Shell continues to look for new business in Russia, according to global oil and gas publication Upstream.

Latest futures prices for oil and gas for delivery over the next six years continue above 40-week averages of about $66 a barrel and $7.80 a million btu. McDep Ratios promise positive appreciation for buy recommendations. Cash flow multiples are low by almost any standard except for sell recommendations. Suggested unlevered portfolio weightings take account of McDep Ratio, geography, line of business, and peer group among other factors.