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Blood in the water

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Mergers offer a chance to cut costs and save money. Prices are low. BP, now fit, lean and cheap, is not best placed to go shopping itself. So it could be on someone else’s list.Screen Shot 2015-01-20 at 22.32.28

The oil giant’s troubles could make it a takeover target, especially if the price of crude keeps falling

INVESTORS in BP are a patient bunch, and well rewarded for it. Britain’s third-largest company pays generous and reliable dividends, making it a mainstay of many private and institutional portfolios. But in the run-up to the oil giant’s quarterly results on February 3rd, some investors are jittery. Although BP’s dividend yield is a juicy 5.8%, its shares have fallen by a fifth over 10 years, greatly underperforming the broader market (see chart) and making total shareholder returns slightly negative. This is mainly because of the Deepwater Horizon disaster in the Gulf of Mexico in April 2010, which cost 11 lives and a stonking $43 billion (and maybe more) in fines, legal bills, compensation and clean-up.

BP has slimmed since then. It has sold more than $40 billion of assets, cutting its size by a third, as it continues to fight (and mainly lose) lawsuits and appeals. Now cheap oil is adding a new edge to its woes. Until recently BP made plans based on an oil price of $100 a barrel. When it announced its latest $1 billion restructuring plan in December, it tried to reassure investors that its investment plans assumed an oil price of $80, but with a fallback level of $60. The price was $65 then. Now it is below $50. As we went to press on January 15th BP was announcing further job cuts.

Not only does existing capital spending (an annual $24 billion-plus) look unaffordable, but those generous dividends—the top priority—will gobble cash. An institutional shareholder wonders if BP may resort to paying next month’s dividend in new shares (or “scrip”). “They are being overwhelmed by events,” he says.

So the chances have grown that one of BP’s rivals will seek to capitalise on its weakness and bid for it. Although its value has fallen sharply, its market capitalisation is still $107 billion, so the list of possible buyers is short. The most talked-about potential suitors are Exxon Mobil (market value $380 billion) and Shell ($197 billion), with Chevron ($196 billion) as a possible “white knight” merger partner to fend off the other two. There are some state oil and gas firms big enough to afford BP (the Saudi, Qatari or Kuwaiti ones, say), but none seems to be in shopping mood just now.

All the firms involved decline to comment. But it is easy to see some advantages to a takeover by Exxon. The two companies fit, in that Exxon’s American business is smaller than its international operations. And BP, though nominally British, is strongest in America. Exxon has lots of cash and low borrowing costs. It did a good job of absorbing Mobil, another rival, in 1999. Moreover, the biggest blight on the BP share price is its American lawsuits. It has handled these badly. Exxon, with its unrivalled political clout, might do better.

Another attraction is BP’s nearly 20% stake in Rosneft, Russia’s biggest and best-connected oil company. Rosneft is in trouble: heavily indebted, cut off from Western capital markets by sanctions, and bailed out by the Russian state in December. But for a far-sighted outsider, Russia’s oil and gas reserves are hard to ignore. BP has made a lot of money there so far. Sanctions forced Exxon, which has deep ties with Russia, to cancel its Arctic drilling project with Rosneft. Buying BP could offer a way back in. It would take a brave boss to do this; but Exxon’s Rex Tillerson is made of stern stuff.

Perhaps the strongest reason for a takeover is not BP’s plight, but the oil industry’s general gloom. The S&P Global Oil index has performed only marginally worse than BP over the past 10 years—it is up just 2.6%. All the big energy companies were wrestling with rising costs and falling reserves even before the oil-price fall. Now they are grappling with its consequences. Mergers offer a chance to cut costs and save money. Prices are low. BP, now fit, lean and cheap, is not best placed to go shopping itself. So it could be on someone else’s list.

BP wants to stay independent. Its bosses believe they have done well since 2010, ending an era of bloat, excessive ambition and corner-cutting on safety. Any buyer would have to surmount some big obstacles. Britain’s former imperial oil company has close ties to the establishment. A sale to an American buyer would mean a political row, in an election year.

It is also uncertain that Exxon would be able to solve BP’s remaining American lawsuits. The biggest headaches are in Louisiana, a state where outsiders tend to fare poorly, whether they are foreigners or just from out of state. Many legal wheels have turned since Barack Obama ostentatiously referred to BP as “British Petroleum” in what some saw as opening the hunting season on the company. One would have to believe that the American legal system was open to influence from politics and money to think that switching ownership would help. Some might say it is, but Exxon would hesitate to argue that case publicly. Boards are usually nervous about buying a company embroiled in lawsuits.

You can’t be sure of Shell

Nor does the idea of Shell taking over its old partner and rival look quite so attractive when examined in detail. BP’s former chief executive, Lord (then John) Browne, did once consider a merger, at a time when his company was top dog. Shell is now the stronger party. It has a solid balance-sheet, and there are some attractive synergies and cost savings to be had.

But big, hostile bids are not the Anglo-Dutch company’s style. It has a lot on its plate. Its big bets on gas and Alaskan drilling are not going well. Whereas BP sold assets when oil prices were high, Shell is now scrambling to do the same at a time when takers are few. This week it had to scrap a huge petrochemicals project in Qatar.

Melding together the two firms’ cultures might be no easier than if Exxon were the buyer. BP has never quite shed its imperial ways, including a climate in which employees feel nervous about bringing the boss bad news. Shell is an engineering-driven company, which sees itself as flatter and more collaborative. Anti-monopoly worries would require complicated and risky untangling of downstream assets—and in hard times.

The risks and costs of trying to buy BP, and then absorbing it, may be enough to make potential predators think twice about having a go right now. And there are plenty of other oil firms they could buy, that would not come with BP’s baggage. But if the oil price stays low, or if BP’s condition worsens for other reasons, all bets are off. The company has changed a lot in the past decade. To guarantee its independence it will have to do even more now.

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