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BP and Royal Dutch Shell now $100 billion apart

BP Struggles to Plug Valuation Gap

May 1, 2012


BP BP -0.88% and Royal Dutch Shell RDSA.LN +1.14% had similar market values just over two years ago: Now they are $100 billion apart. That difference first opened up thanks to uncertainty over BP’s final legal cost from the Gulf of Mexico oil spill in April 2010. But the two oil majors’ underlying performance is also diverging: BP’s first-quarter net income fell 12.8% year-on-year, while Shell’s was up 16%. That is making it harder for BP to close the valuation gap.

BP’s output is still 13% down on the first quarter of 2010. Worse, it has lost production in high-margin areas like the Gulf of Mexico while rivals increase more profitable output. BP’s net income from each barrel of oil equivalent produced has fallen to $14.23 from $14.87 two years ago, according to Sanford C. Bernstein; Shell’s has risen 46% to $19.69. It expects production to rise by 6% this year, whereas BP forecasts no growth. Accordingly, BP trades at a 19% discount to Shell based on expected 2012 earnings, accounting for $45 billion of the valuation gap.

Explaining the rest requires more pessimistic assumptions. First, the oil spill bill would have to be much higher than BP’s current $37.2 billion estimate. Yet BP is closer to finalizing that cost. It has agreed on a $7.8 billion settlement with individuals affected, and received $5.5 billion in compensation from some contractors. The biggest uncertainty remains potential U.S. Clean Water Act fines: If BP is found to have been grossly negligent its total cost could be nearer $48 billion.

That worst-case scenario still leaves around $7 billion of the valuation gap unexplained. Sure, BP has other issues. Relations with its partners in joint venture TNK-BP are tense, putting the $22 billion value of its 50% stake at risk, J.P. Morgan JPM +2.12% suggests. It could lose $7 billion if Argentine subsidiary Pan American Energy—which it is hoping to sell—is nationalized, as Repsol‘s YPF YPF -0.41% has just been. It could write off half the value of its $7 billion investment in India last year, given slow progress there so far.

These remain remote possibilities. But BP’s problem is that until its actual results recover, investors won’t give it the benefit of the doubt.

Write to Andrew Peaple at [email protected]

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