Although natural gas prices remain depressed in the U.S. due to unusually low demand, companies like BP that continue to focus resources on these plays will be in a better position to compete as liquid reserves are depleted. The net margin on dry gas from unconventional plays only grows as fracking becomes more sophisticated, and BP, with its experience and deep R&D budget, is prepared to exploit these opportunities. Given BP's focus on exploration and production and divestiture of non-core assets in its latest annual report (pdf), it appears that BP's leadership is well aware of the need to be dexterous in the coming years, and won't be swayed by a temporary downswing in commodity prices.
Although in the U.S. dry gas prices decreased 8% in 2011 over 2010, in Europe prices increased an average of 33% for the same period. BP's global reach helped offset losses and storage costs for a commodity that had very low demand stateside. Despite growing calls for stronger carbon policies in OECD countries, BP is predicting (pdf) that oil and gas consumption will fall only slightly in the coming decades, from 57% today to 53% in 2030.
BP believes (pdf) that natural gas will be the fastest growing fossil fuel over the next 15 years, and has plans to exploit this resource through agreements with the governments of Oman, Algeria, and Indonesia. Seeing that the future of profit does not lie in solar, BP is preparing (pdf) to exit solar and focus on exploration and production of carbon resources. At the close (pdf) of 2011, BP had net proved reserves totaling 17.7 mboe, 40.5% of which is in gas. The remainder is in liquids, including liquid natural gas (LNG).
According to its 10-point plan to increase shareholder value, BP intends to bring new upstream projects online with unit operating cash margins double its 2011 averages. According to its latest (pdf) upstream operating model, BP plans to do this mainly through more strenuous safety and operational risk management and increased recovery. Its plans for increased recovery include the 4D "Field of the Future" technology program, which has already located 25 additional well targets in the Greater Plutonio.
BP reached settlements (pdf) in 2011 totaling $5.5 billion related to the Macando blowout, and continues to work through the Multi-District Litigation in New Orleans. This litigation will resolve a majority of outstanding claims over the disaster, except for those claims brought by federal, state and local governments, and shareholders. Across 2010 and 2011, BP spent (pdf) over $26 billion in expenses related to the Deepwater Horizon spill. However, its earnings per share on a three-year average are still positive, standing at 1.7%, compared with a negative industry average of -5.8%.
Shareholders are concerned that BP's culpability over Macando will hurt its ability to receive drilling permits in deepwater. However, as its 2011 annual report shows, BP continues to receive deepwater approval from regulators across the globe, including approval for major projects in the U.S., Trinidad and Tobago, and Angola, in addition to its acquisition of 10 exploration and production blocks from Devon Energy (DVN) in Brazil. Overall, BP gained (pdf) 55 new exploration licenses in nine countries in 2011, and plans to increase its exploration investment over 100% through 2015.
Entanglement in TNK-BP
Exxon Mobil (XOM) recently announced a deal with Russian state-owned oil company Rosneft, in which Exxon Mobil will receive access to reserves in the Kara and Black Seas in Russia, which have estimated reserves exceeding Exxon Mobil's current reserve base. In return, Rosneft will receive interest in certain of Exxon Mobil's holdings, and at least partial access to Exxon Mobil's modern shale extraction techniques, technology the Russian oil giant lacks. This deal was followed up with a second, similar agreement by Rosneft, this time with Italian producer Eni.
This is a huge blow to BP, as BP attempted to form a similar deal with Rosneft in 2011 that collapsed when Alfa Access Renova, with whom BP operates joint venture TNK-BP, challenged the deal in international court, based on an exclusivity clause between BP and Alfa Access.
The United States Geographical Survey estimates that up to 160 bboe could lay beneath the Arctic continental shelf; this is conservative compared with Rosneft's estimate of 206 bboe. Over half of the Arctic territory is controlled by Russia, and as perennial and annual sea ice melt rates increase, these reserves are increasingly accessible. It appears to me that BP made a mistake in its deal with Alfa Access Renova. While the partnership allows TNK-BP considerable preferential tax treatment in Russia, TNK-BP's 2010 annual report reveals no plans for offshore exploration. TNK-BP is also facing legal action brought by Russia's natural resources and ecology minister over legacy and continuing environmental damages, which makes it unlikely that TNK-BP will be able to maneuver into government-controlled off-shore contracts in the near future.
In the U.S., the Environmental Protection Agency quietly indicated that regulations for hydraulic fracturing would be phased in through 2015. Ordinarily BP might be considered large enough to withstand the costs of sudden compliance with sweeping regulation, but in its current position this is good news for BP as well as for its large- and small-cap competitors operating non-traditional natural gas plays on the North American continent.
The costs of the Macando blowout are negatively impacting returns and outlook for BP, as even BP's leadership will not venture (pdf) an exact estimate of the ultimate cost of the disaster. This has BP trading low. Currently around $43 per share, BP is trading at 70% of its levels immediately before the consequences of the blowout became apparent. This gives BP a forward price-to-earnings value of 5.3 and a price to book of 1.2.
BP's major competitors have similar value ratios, though none of them is facing litigation costs as massive as BP. Chevron (CVX) comes close, with its ongoing defense against Brazilian claims totaling $22 billion for environmental damages related to a spill in the deepwater Frade field. However, this is not depressing Chevron's value to stockholders as of yet, as the stock currently trades at a P/E of 7.8 and a P/B of 1.7.
Royal Dutch Shell (NYSE: RDS.A) is also facing lawsuits over environmental damages, although the monetary damages it might be facing are as yet unclear. Trading at a similar value to its competitors, Shell has a P/E of 7.3 and a P/B of 1.3. At a slightly better value with a more positive outlook, Total SA (TOT), the world's second-largest LNG player after Shell, has a P/E of 6.5 and a P/B of 1.3.
Finally, Exxon Mobil, while outperforming its peers by a small margin, is not seeing a strong lift from its announced partnership with Rosneft, though its relative freedom from complex international lawsuits shows in its ratios. At $86 per share, Exxon Mobil has a P/E of 9.5 and a P/B of 2.6.
If energy prices stay high, BP could have a positive outlook. Current indicators are that BP will be able to repay the obligations it incurred in the Macando blow out while continuing to prove and exploit new plays. BP's dividend rate increase in February 2012 helped restore shareholder confidence further. I think that since BP is selling low relative to assets and conservative outlooks, it is an attractive buy.
BP will announce its first-quarter 2012 results on May 1.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.