Please ensure Javascript is enabled for purposes of website accessibility

For BP Plc, a Free Long-Term Call Option

By Jay Yao - Feb 25, 2014 at 10:08AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

BP's Russian assets are not loved by the market but could pay off in the long run.

How much are BP's (BP 2.69%) Russian operations worth?

Apparently not that much.

When the British oil company traded 50% of its Russian subsidiary TNK-BP for $12.5 billion in cash and 19.75% of Rosneft, many market participants said it would have been better for BP to get more cash upfront instead of Rosneft equity. When ExxonMobil (XOM 1.28%) announced that it would help Russia develop its vast Arctic reserves, the super-major's stock barely budged. 

Why is the market valuing Russian oil and gas companies so cheaply?

Low valuations 
On the surface, the low valuations for Russian oil companies make no sense. Compared to the other oil-rich nations out there, Russia is the best house on the block. The nation is geopolitically stable. It has large untapped oil and gas reserves. In China, Russia has a cash-rich neighbor willing to invest money upfront to fund future production.

As an example of China's willingness to invest, last year, Rosneft signed a $270 billion deal with China National Petroleum Corp to supply around 360 million metric tons of crude oil to China over 25 years.  

In addition to the positive macro outlook, the valuations for Russian oil and gas companies are compelling. Russia's oil giants are super-major size but trade at half the price. Rosneft itself has more than 30 billion barrels of proven oil and gas reserves. The company produces around 4.88 billion barrels of oil equivalent every year, more than ExxonMobil's 4.02 billion. The Russian firm's production costs are also lower: Rosneft's lifting cost per barrel is $3.70 versus ExxonMobil's $12.30. 

Despite the many positives, Rosneft trades at 5.4 times earnings versus ExxonMobil's 13.

The challenges ahead
The low valuations could be because much of the future growth will occur in the Arctic.

While the Arctic does hold promise, with an estimated 85 billion barrels of oil equivalent in Russia's Kara Sea alone, developing Arctic fields will be extremely challenging. 

Some challenges include the extremely frigid weather, difficult geology, limited existing infrastructure, and long project lead times. The Arctic oil companies will need to develop new technologies and processes to extract oil safely and efficiently. 

Given the long project timelines, there is also the risk that Russia could amend project terms later on. Even though BP has had great success in its Russian venture, Royal Dutch Shell (RDS.A) has had some troubles. In 2007, Russia forced Royal Dutch Shell to sell half of its controlling stake in the Sakhalin-2 field, which ended up costing more than double the initial $10 billion price tag. While the Anglo–Dutch firm will still make money from the project, it is a sign that terms can change.

Because of the many challenges ahead, investors are assigning higher discount rates when calculating the net present value of the oil fields. The higher discount rates explain why the market is not valuing Russian oil and gas assets so highly.

The bottom line
Right now, the market is in show-me mode, where it will only believe Arctic cash flows when it sees it. Market sentiment can change, however. If Western companies continue to realize generous profits from Russia, the market will likely value Russian oil and gas assets higher.

For long term shareholders of BP, the low valuation provides a free call option for the case when the market does decide to value Russian assets higher or when the Arctic projects start pumping oil. In the meantime, Rosneft's 3.22% annual dividend will just add to BP's bottom line. 


Jay Yao has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Royal Dutch Shell plc Stock Quote
Royal Dutch Shell plc
Exxon Mobil Corporation Stock Quote
Exxon Mobil Corporation
$91.73 (1.28%) $1.16
BP p.l.c. Stock Quote
BP p.l.c.
$31.26 (2.69%) $0.82

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/11/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.