The Bearish Case Against BP

Back in 2010, it wasn't too far of a stretch to think that the Macondo spill could send BP (NYSE: BP  ) into a tailspin from which it would never recover. Three years on, that incident possibility is looking like less and less likely. Still, there are some reasons to think BP may never be the same again. Let's take a look at three reasons against investing in the company. 


Can it handle another Macondo spill?
There's no doubt that BP has taken a huge hit since Macondo. So far the company has paid out almost $42 billion in penalties and spill recovery payments, with another potential $55 billion pending the result of the two remaining court rulings. So far, the company has had to sell off more than $38 billion in producing assets to cover spill liabilities, and it's very possible it will need to sell off some more if these court rulings hit the company hard. Based on the company's balance sheet and cash flows, BP will be able to survive this spill and could potentially come out the other end as a stronger company.

On the other hand, 60% of BP's oil production comes from either deepwater formations or from higher-risk onshore operations such as the Alaskan North slope. With so many of its operations in these higher-risk environments, it increases the company's chances of having another major oil spill. Also, countries are putting more and more teeth into penalties for companies that spill oil, so the next one to have a major spill could see higher penalties. If BP were to have another Macondo-type spill in the near future, the same questions that were raised a couple of years ago could come roaring back.

Disadvantaged downstream assets
This year, BP sold both its Texas City refinery to Marathon Petroleum and its Carson refinery to Tesoro. This represented more than 50% of BP's total crude refining capacity in the U.S. as well as chemical production capacity. Granted, BP generates only 8% of its earnings from the downstream side of the business, so losing these assets may not be a huge hit. What does make this move questionable, though, is that the company decided to shed its U.S. assets instead of some of its more disadvantaged downstream assets.

Much like the other European integrated majors Royal Dutch Shell (NYSE: RDS-A  ) and Total (NYSE: TOT  ) , BP has a large concentration of refineries and chemical manufacturing facilities on the European continent. Following the sale of the Texas City and Carson refineries, European refineries now represent more than 40% of BP's refining capacity. This could potentially come back and bite BP because of the current situation we're seeing in the refining space today. Thanks to the boom in U.S. oil production, U.S. exports of petroleum products have hurt European refineries the most, with Total shuttering two refineries already this year and plans to close a third by the end of the year. 

If the European market continues to struggle as it has, the downstream side of BP's business could end up being a major drag on earnings and cause the company to underperform.

Source: BP Media Relations.

Death by decline
Last year, BP drilled more than 1,000 net successful development wells, which for many exploration and production companies would be a very impressive number. What's staggering about this number, though, is that despite successfully completing that many wells, BP's total hydrocarbon production actually slipped 3.5% year over year. With more than 55,000 wells producing oil and gas for the company at various stages of decline, BP has a massive task of just keeping up with the decline of its existing assets. 

Even more concerning is that the price to replace those reserves is getting greater by the day. Chevron (NYSE: CVX  ) executives have noted that the cost for drilling oil in the Gulf of Mexico has gone up by 20%-25% as a direct result of the Macondo spill. This will have a profound impact on Chevron and BP, since they both have so much production in the Gulf, as well as plans to develop their assets there even further. 

Whenever we talk about the exploration plans for these integrated oil and gas companies, we want to look for those major projects to move the production. The reality is, though, that just keeping the needle steady is a daunting challenge in itself. The pressure to grow production finally cracked Shell this past quarter, and the company has scrapped its production growth targets to focus more on profitability of its existing production. BP is finding itself in a similar position, although because of the Macondo incident.  

What a Fool believes
Many of today's integrated oil and gas companies are up against some mighty challenges to improve both production and financial performance, and BP is no exception. For the reasons that BP may underperform for the next couple of years, there are also some reasons to think that the company can turn it around. BP is in the middle of a major reshuffling of its assets, so both doubters and investors in BP should watch what comes from this turnaround before making any definitive decisions. 

One company that could dictate BP's success
For BP and many of the other integrated major oil companies, exploration is getting extremely expensive. To mitigate this risk, they need to be extremely good at identifying potential well sites. There is one behind-the-scenes energy company that is built to help Big Oil do just that, and make big profits along the way. The prospect for this company is so great, our chief investment officer has selected it as his No. 1 stock for this year. In our comprehensive report "
The Motley Fool's Top Stock for 2013," we outline how this company will change the way we drill for oil and give you the name of this under-the-radar-company. Simply click here and we will give you free access to this valuable investing resource.

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