Whenever there is any talk about BP (BP) and its future prospects, there are two key areas that dominate any discussion, namely the company's business in Russia and the effects of the disastrous Gulf of Mexico oil spill. Any meaningful discussion about the company as an investment prospect requires a clear understanding of both issues.
The Russia story involves a long, drawn-out and bitter quarrel between BP and its partners in Russia's third biggest oil firm TNK-BP. The firm is owned equally by BP and a consortium of three Russian billionaires called Alfa Access Renova (AAR) and is hugely profitable having paid out dividends of over $7 billion last year. TNK-BP was founded in 2003 to combine the Russian oil assets of the partners with an investment of $8 billion by BP, which is the biggest ever foreign investment in Russia. The benefits were clear for BP which was looking to Russian oil reserves to offset declining production in Alaska and the North Sea. The benefits for the Russian partners were less clear but presumably included access to state of the art Western technology as well as some degree of protection from the Kremlin.
TNK-BP has been outstandingly successful because it was able to increase production from existing oil assets by around 40%. The company represents almost 30% of BP's oil and gas production, 27% of its reserves and around 10% of its income. In the past nine years, BP has received dividends worth $19 billion from the company. The disagreements started to show by 2007 when AAR claimed that their ambitions to expand the company outside Russia were being blocked by BP.
Last year, the situation deteriorated when BP announced that it had set up another joint-venture in Russia with Rosneft for exploration in Russia's Arctic Kara and Black seas. Finally, BP tried to buy out the AAR stake for $32 billion but the bid was unsuccessful. After this, TNK-BP became virtually ungovernable as two directors resigned and the board of directors was unable to form a quorum. As a result, no dividend is paid to the first quarter of this year. The company CEO has also resigned. Possible buyers for the BP stake could be AAR (though it is doubtful whether it can raise the necessary cash) or the big Russian state-owned energy giants Gazprom (OTCPK:OGZPY), Rosneft (GM:RNFTF) or its holding company Rosneftegaz. The BP stake is valued at anything between $18 billion and $35 billion and BP has reiterated that it remains committed to Russia and its Russian businesses.
I would now like to consider the implications of the developments in Russia in so far as it concerns the BP stockholders. I would guess that, for whatever reason, BP appears to be unwilling to sell its stake to its existing partners. The advantages for BP from the sale of the mountain of cash it will receive to help it with its Gulf of Mexico liabilities and the freedom to concentrate on its Russian oil and gas business without the acrimony of the partnership. The company will also be free to pursue other business ventures in Russia. I consider it extremely unlikely that their major global competitors such as Exxon Mobil (XOM) or Shell (RDS.A) will seriously consider buying the BP stake.
Regarding the other important issue, there is still a lot of uncertainty about the civil and criminal liabilities as well as the penalties that BP faces as a result of the 2010 oil spill in the Gulf of Mexico. It is reported that BP is seeking a $15 billion settlement with the U.S. Department of Justice to cover all civil and criminal liabilities as well as penalties.
The main advantage of the settlement is that it would completely eliminate the chances of a trial in court. The US Department of Justice is seeking $25 billion and BP has separately reached a $7.8 billion with third parties. A $15 billion settlement would represent a satisfactory outcome for BP which has already set aside more than $37 billion towards all the claims arising out of the oil spill. You should also remember that Transocean (RIG), Halliburton (HAL), and Cameron (CAM) have a liability as well and are in turn being sued by BP for damages.
I would consider that the worst of BP's problems are now behind them and under control and I would now strongly recommend a buy. The company has operated successfully for decades through the ups and downs of the oil and gas business and there is no reason to assume that they will not continue to do so. Declining oil prices are currently another area of concern, but I am sure that the company would cope.
BP has initiated several exploration projects in areas such as Angola, Brazil and new Gulf of Mexico projects and the latest news is that they are going to resume activity in Libya. Substantial investments are being made in the Whiting Refinery in Indiana which is already about two thirds complete. BP expects all these investments to improve operating cash flow by about 50% in 2014 and is looking to double its operating margins in exploration and production compared to the levels in 2011.
The dividend yield of around 4.9% is attractive compensation while you wait for the stock to rise. At the very minimum, you should continue to hold any existing investments and be compensated by the dividend yield while you wait for your capital appreciation.