Last updated: January 1, 2013 6:59 pm

Remaking BP has yet to pay off

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BP has carried out one of the most radical asset disposal programmes in UK corporate history over the past two years. It is a strategy some have called “shrink to grow”. But while the shrinkage is clear, BP’s promised growth is still some way off.

The immediate trigger was Deepwater Horizon, a disaster that at one point threatened BP’s very survival. Facing billions of dollars of damages claims over the Gulf oil spill, and the threat of even larger fines, it had an urgent need to raise cash.

But the accident was also seen as a chance to remake BP. Bob Dudley, the group’s American chief executive, said he saw an opening to create a “more focused oil and gas company” with a portfolio “based on high-margin opportunities”.

That has certainly been achieved – and with a speed that has impressed analysts. BP initially said it would sell $38bn of assets by the end of 2013. It has almost reached that target already, a year earlier than planned. Including the sale of its half of TNK-BP to Rosneft, the total proceeds reach a staggering $65bn.

“The scale of this divestment programme is unprecedented,” says Stuart Joyner of Investec. Including the Russian sale, BP has converted just under a fifth of its $300bn capital employed into cash in less than two years, he says.

The effect has been dramatic. “BP is leaner, trimmer, fitter than it was, and the right size to deliver value,” says Jason Kenney of Santander. “There is a silver lining to the whole Macondo [Deepwater Horizon] disaster after all.”

One of the most striking changes has been the reduction of BP’s downstream operations, with the sale of its huge Texas City and Carson refineries in the US. That has been combined with a renewed focus on the upstream, or exploration and production – a process so pronounced some analysts now describe the new-look BP as a “super-explorer”.

Demons still remain to be exorcised

Bob Dudley has been on a mission to exorcise the two big demons tormenting BP – uncertainty over the final bill for the Deepwater Horizon disaster and a Russian joint venture crippled by conflict. Despite substantial progress on both issues, question marks still persist, writes Guy Chazan .

On the Gulf disaster, some deals have been reached, but a comprehensive settlement of all outstanding Macondo-related liabilities has so far eluded the company.

On Russia, progress has been more tangible. The company is selling its 50 per cent stake in Russian oil producer TNK-BP to Rosneft, in a deal that leaves it with $12.3bn in cash and a 19.75 per cent stake in the Russian state oil company. Champagne flowed at BP headquarters as it finally severed its ties with AAR, the consortium of litigious oligarchs who were its partners in TNK-BP. BP expects the whole transaction to close in the first half of 2013.

Some analysts worry, however, about where it leaves BP. TNK-BP was a cash machine that churned out $19bn in dividends to BP alone and accounted for more than a quarter of the UK oil group’s production. Many wonder what kind of influence BP will have on Rosneft, a company effectively controlled by the Kremlin.

BP counters that although it will get fewer dividends, the $12.3bn cash proceeds from the sale are equal to seven years of TNK-BP payouts. And though its reported production will be slightly lower, the reserves it will be able to book will increase.

More to the point, BP says, the deal opens a world of “world-scale future opportunities” in Russia, in the oil-rich Arctic and in the huge shale resources of western Siberia.

“The production and reserve potential of Rosneft is about four times as big as TNK-BP was 10 years ago,” Mr Dudley said recently. BP and Rosneft had the chance to “create a truly world-class company.”

To that end, BP has been snapping up huge new territories to drill. Since early 2010, it has accessed about 400,000 sq km of new acreage – more than double the area secured in the previous nine years. It has branched out into frontier regions such as Uruguay and Canada’s Nova Scotia, and added new prospects in deepwater Brazil and Namibia.

“We have tripled our [exploration] prospect inventory over the past five years and have now begun to test it,” Mr Dudley recently told analysts attending a BP upstream seminar.

The company has also radically simplified the upstream. As well as selling 10 per cent of its oil and gas reserves, it has divested a huge amount of kit, cutting the number of upstream installations it operates by 50 per cent and the number of operated wells by about a third. This, Mr Dudley says, “significantly reduces complexity and risk”.

The scale of this divestment programme is unprecedented . . . They are turning a corner – but it’s a very long corner

- Stuart Joyner, Investec

Putting key growth assets and exploration at the heart of the strategy is “a simple and interesting proposition”, says Alastair Syme of Citigroup.

But no one expects results soon. “This is just an inventory of prospects – drilling and exploring them will take a long time,” says Stephen Thornber, global equity fund manager at Threadneedle. “[The strategy] might deliver, but certainly not in 2013 or 2014.”

BP itself admits that the turnround will take time. In the short term, production will be dampened by its huge divestments – down 150,000 barrels a day in 2013 compared with last year. Analysts expect earnings to be depressed for the next year at least.

But beyond that, the future looks rosy, BP says, and 2014 should be a break-out year, with highly profitable production kicking off in the Gulf of Mexico and Angola. The company says operating cash flow in 2014 will be $30bn-$31bn – 50 per cent higher than in 2011 – thanks to the completion of payments into the $20bn Gulf of Mexico trust fund; the end of a major upgrade to its Whiting refinery in the US; and the start-up of 15 major new projects over the next two years.

So far, though, investors remain somewhat unconvinced. BP’s shares are still a third down on the levels they were that fateful day in 2010 when the Deepwater Horizon drilling rig blew up, killing 11 men and triggering the worst oil spill in US history. According to Macquarie, the stock trades on 7.1 times 2013 estimated earnings – a 13 per cent discount to peers.

The problem for many is that BP still has not been able to draw a line under the Gulf disaster. In December a US court approved a $7.8bn settlement between the group and private sector plaintiffs affected by the spill. The previous month, BP agreed to a $4.5bn settlement to resolve criminal charges relating to the disaster. But it still faces claims for civil penalties and damages from federal, state and local authorities. A trial is due to start in February.

There are hopes that the remaining civil claims will be settled out of court. But until there is some clarity on how big a hit BP will take, the jury seems to be out. That underscores the difficulties BP faces as it tries to escape the shadow of its 2010 annus horribilis.

“They are turning a corner – but it’s a very long corner,” says Investec’s Mr Joyner.

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