Big oil will live on, but faces a harder future

Kathleen Brooks
AS BP steps up its efforts to stem the oil leak in the Gulf of Mexico, the speculation surrounding the costs associated with the clean-up continues to increase. BP estimates that the cost will be roughly $4bn, while some analysts predict that the clean-up, along with related lawsuits, could be as high as $10bn. While oil continues to gush off the US coastline and a regulatory backlash by the US authorities gathers pace, the question has to be asked: will integrated oil companies survive this disaster?

Integrated oil companies – which engage in all phases of the oil business, from looking for oil to selling the refined products – have become predominant in the energy business during the last 30 years. Companies such as Royal Dutch Shell, Exxon Mobil, Chevron and of course BP, dominate stock indices and have large amounts of financial firepower. This has helped them to use expensive techniques such as deep water drilling in their quest for more oil, but this could now be their downfall.

Since the 20 April explosion, one third has been blown off of BP’s value, even though BP operates many wells and is still generating cash from its refining, marketing and trading businesses. However, as Barclays Capital notes: “As the incident in the Gulf of Mexico has demonstrated, even the very biggest companies can be adversely impacted by single events.”

While there is no doubt the cost of the clean-up operation will be a big chunk of change for BP, there are no solid signs that this disaster will break “big oil”. Tony Shepherd, research analyst at stockbroker Charles Stanley, says that this crisis is unlikely to affect the oil sector’s business models, although it could have a long-term impact on the overall industry: “It’s too early to jump to any conclusions about what the exact impact will be, but I think it’s fair to say that new regulations will affect all oil companies, regardless of whether they are pure exploration, integrated or pure refining.”

Last month, US president Barack Obama extended a moratorium banning all oil drilling off the Gulf of Mexico for at least six months. Shepherd says that the oil industry has to brace itself for a domino effect, with more stringent global regulations becoming the norm: “Norway has already introduced new measures and improved safety standards; this will probably spread to the Far East, Africa and Australia, which will make it more costly to look for oil in deep waters.”

But what does this all mean for investors, and should they avoid the energy sector? Investors who still fancy a strong oil price, but would prefer to limit their exposure to the after-effects of the BP oil spill, should consider going long on oil service companies with little or no deep water exposure, such as Petrofac, Hunting and Lamprell, while avoiding exploration companies that have exposure, including Technip, Saipem and Acergy.

But yield-hungry investors might want to take another look at beleaguered BP. Alex Stewart, a director at Evolution Securities and who isn’t forecasting a dividend cut, says that even if the scenario arises whereby BP does reduce its dividend by half – currently the 12-month forward yield has surged to 9 per cent as the stock has slumped– it would still yield more than the overall market, which currently averages 3.9 per cent.

So, do you sell BP shares or give them another chance? Its share price fell by nearly 25p yesterday to 429.75p, and it remains far from clear what the future holds for the oil major. BP’s share price has always been at the mercy of operational risk – it still has to plug the leak – but it now faces extra political risk, and US authorities look like they won’t stop until they get their pound of flesh for the spill and the damage to its coastline.