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Unconventional wisdom: Case for buying BP

|Includes: BP p.l.c. (BP)

Since the Macondo disaster--the explosion and sinking of the Deepwater Horizon drilling rig in offshore Mississippi Canyon block 252 and subsequent oil spill--BP has been everyone's bete noire. Yet, like Exxon after the Valdez, there appears to be strong potential BP has changed its operating procedures and may be returning to a more 'boots-on-the-ground' culture. The US government is allowing BP to again bid on leases and to act as operator in the offshore Gulf of Mexico. Last week, Anadarko settled its portion of Macondo claims with BP for $4 billion. Mitsui, its other partner on Macondo, settled earlier.

In particular, despite--or even perhaps because of--the many mistakes that led to the Macondo disaster, BP is one of the few companies with the experience and size to operate in ultradeepwater offshore. Ultradeepwater offshore GOM will continue to be an important domestic oil producing province for many years.

At a time when Brent costs $110/barrel, oil producer BP has a price/earnings ratio of 6.74, based on the 10/21/2011 close of $42.35/share. (The DJIA closed at 11,808 on 10/21/2011.) Reflecting the uncertainty of the liability associated with the spill, BP's common stock price in the last year has ranged between $33.62 and $49.50/share. Prior to the spill, BP's share price topped $60/share at a time when the DJIA was 11,000. BP's consensus one-year target price is $52/share.

Let's be crystal-clear about Macondo. BP, as operator and by contract, had fairly complete responsibility for all decisions made on the Deepwater Horizon drilling rig. Those decisions included not fully circulating the drilling mud, running a single long string of casing instead of multiple individual strings, using 6 centralizers instead of 21 called for by the drilling plan, not running a cement bond log, incorrectly interpreting the negative pressure test, and replacing the drilling mud with seawater at what appears to have been a premature point. There is also uncertainly about whether there was a gas zone several hundred feet above the bottom of the well. If there was, cementing was incomplete.

11 people were killled and 17 were injured in the explosion. The well, which turned out indeed to have been productive, flowed three months before it was capped. It spilled an estimated 4.9 million barrels of oil, making it the largest accidental marine spill ever.

The trial, which is estimated to require several months and will take place in three phases, starts in late February 2012. Findings could include gross negligence or criminal charges, both major negative uncertainties.

BP has set aside $20 billion for damages. Its market cap is $133.7 billion at Friday's close. Despite stumbles, BP continues to be a major player in Russia as well as the US.

While I am a fan of US oil shale production, it is worth noting that 30% of 2010's oil production came from the US Gulf of Mexico (NYSE:GOM). The GOM has 3500 platforms and companies have made 65 discoveries in over 5000 feet of water. BP's Thunder Horse in the GOM, which came on 3 years late due to damage from Hurricane Dennis when a check valve installed backward caused the plaform to flood, nonetheless produces 260,000 BPD of oil and 220 MMCF/Day of gas from seven wells, the most production from an individual platform in the Gulf. Moreover, BP is an experienced operator; for example, in 2006-2007 it had six of the twenty largest-volume platforms producing in the GOM.

BP pays a $1.68/share dividend, about 4%. One out of every seven pounds of dividends in the FTSE 100 is paid by BP. 18 million people in the UK either own shares or pay into pension funds that own shares in BP. 39% of its shares are held in the US including holdings by Fidelity, Vanguard, State Street, Invesco, Bill and Melinda Gates Foundation, Barrow Hanley Mewhinney & Strauss, and Franklin. As of 12/31/2010, BP's liabilities were $177 billion and its assets were $272 billion, a liability/asset ratio of 65%. BP's estimated 2011 production is 3.4 million barrels of oil equivalent; its reserves are 18 billion barrels of oil equivalent. BP also has substantial refining (2.4 MM BPD), chemicals, and other businesses.

BP's assumption of responsibility in the Macondo spill, genuine effort to remediate the damage, and change in procedures suggest a change in the operating culture that make it an interesting candidate for investment. Significant uncertainty remains, to be played out over the next 12-18 months.

Disclosure: Author does not plan to transact in BP securities in the next 72 hours.