BP Is Still A High-Risk Share

Published in Company Comment on 8 August 2012

Royal Dutch Shell and BG Group look better long-term holds.

You expect FTSE 100 (UKX) companies to be solid, dependable and boring. At least stock-market nostalgia suggests that used to be the case. 

Yesterday's 24% plunge in the share price of Standard Chartered (LSE: STAN) is just the latest in a string of unfortunate incidents that have savaged the pockets of investors since BP (LSE: BP) (NYSE: BP.US) suffered the Deepwater Horizon disaster.

BP's catastrophe arose out of a poor safety culture, and maybe a large dose of bad luck. But it is a high-risk company that takes big bets, and nowhere is that more evident than in its Russian joint venture.

In 2003, BP folded its Russian interests into TNK-BP, a 50/50 joint venture with a consortium of oligarchs called AAR. The venture has proved to be a great operational success, and now accounts for a third of BP's production and a quarter of reserves. Dividends from TNK-BP funded most of BP's own dividend last year.

Tensions

But there have been tensions from the outset. To seal the deal, BP gave AAR first refusal to participate in all of its activities in Russia. BP's flirtations with State-owned oil and gas companies Rosneft and Gazprom, both run by executives close to President Vladimir Putin, inflamed the oligarchs. Robert Dudley, then TNK-BP's CEO, fled the country in fear for his safety.

During June, BP announced it had received 'unsolicited approaches' to buy its 50% interest, which the group intends to pursue. The following month, Rosneft said it was interested in acquiring the stake. AAR is negotiating to acquire half of BP's stake, which would give the oligarchs control in the venture. BP says it will sell all or nothing.

A legal case brought by AAR against BP rumbles on in the background. Last month, a minority investor won a £3 billion damages claim against BP in a remote Siberian court, a case widely seen as lacking merit but designed to put pressure on BP. AAR has blocked dividend payments from TNK-BP, which will constrain BP's cash flow.

Russian lessons

There are features of this story that are familiar to many foreign businesses operating in Russia:

  • Russians prefer joint ventures where they have control;
  • Local partners can have hidden agendas;
  • Hostile actions may be conducted through third parties;
  • The government may interfere. Tax and other regulatory authorities, or state-owned entities, are common weapons of choice;
  • It's not just government, but politics. Who's in or out of power matters;
  • Courts are unreliable. The further they are from Moscow, the more brazen they may be, and;
  • If things turn bad, they can turn physical.

The remarkable thing is that a company the size of BP should bet so much of its business in such an environment.

Pundits have had a field day speculating on possible outcomes. They assume BP has a choice, but it seems to me that in the monumental struggle between the Russian state players and powerful oligarchs, it's quite possibly BP that will get squeezed and be forced to accept an offer it can't refuse.

High risk

So it's high risk stuff. BP's shares still trade at a discount as it claws its way back from the Deepwater Horizon disaster. If the company pulls off a good result in Russia, and the final cost of its US misadventure isn't too severe, its shares could rocket. But the risk of things going the other way is still very real.

It's quite a different scenario at BP's FTSE 100 peers.

Royal Dutch Shell (LSE: RDSB) is much more diversified across geographies and technologies, with a big emphasis on natural gas. BG Group (LSE: BG), which is mainly involved in gas, has technological challenges to bring its massive Brazilian and Australian reserves into production, but the political risks here are lower. To my mind, Shell and BG are the better long-term holds.

Companies in the oil and gas sector can be high risk, but of course they can also provide high rewards. In my view, diversification is one of the best ways of managing the inherent investment risks of this particular industry. 

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> Tony owns shares in BG, Shell and Standard Chartered but no other shares mentioned in this article. The Motley Fool owns shares in Standard Chartered.

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Comments

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Boystown 08 Aug 2012 , 4:42pm

The whole point is all this stuff is already reflected in the price. If BP was on the same P/E as Shell, its shares would be 565p.

equitybore 08 Aug 2012 , 5:15pm

One has to wonder about the competence of BP management. One cardinal rule of joint ventures (JV's) is NEVER EVER go in on a 50/50 split. JV's are common in the oil and gas industry, but even the most brain dead corporate planner should have seen the track wreck that was bound to happen down the road with this one.
BP is a serial disappointer for me...

MAACPRIME 08 Aug 2012 , 9:12pm

What about Chevron and Exxon Valdez?

ANuvver 08 Aug 2012 , 10:22pm

Sechin had boiled eggs for breakfast this morning. He asked for his toast to be cut up into Dudleys.

Dozey1 09 Aug 2012 , 10:12pm

Why haven't we been told what Woodford thinks about it?

goodlifer 10 Aug 2012 , 2:39pm

Yes, we're all dying to know.

ryderjohnsmith 11 Aug 2012 , 11:56pm

I went to crack an egg into the pan this morning but I found the hard way that my wife had hard boiled them all.

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