Is BP back? Only partly

Last week's $7.8 billion settlement is really just one small step.

By InvestorPlace Mar 8, 2012 11:00AM

Scott Gibson/CorbisBy Aaron Levitt

 

A short time ago, BP (BP) reported pretty decent earnings (minus its refining unit), and many analysts and pundits hinted at a potential turnaround for the company. The integrated energy major, whose 2010 Deepwater Horizon rig disaster in the Gulf of Mexico killed 11 workers and created one of the worst oil spills in recent history, has been fighting a tough battle since that tragedy.

 

Poor earnings, legal overhang, a dwindling dividend and public backlash have hampered the company's prospects in the nearly two years since the spill. While the recent improved earnings certainly took away one of the major problems, BP's huge liability issues were still cause for concern for investors.

 

However, shareholders recently received some good news on the legal front. With shares of the oil major roughly 13% higher this year and trading near a 52-week high, the question remains: Is BP a buy?

 

Not out of the woods yet

 

Chalk one up for BP's legal department. The company announced on March 3 that it had reached a settlement with the various condominium owners, fishermen, restaurateurs and other individuals whose livelihoods were damaged by the Macondo disaster. The Plaintiffs' Steering Committee (PSC) settled with BP for nearly $7.8 billion, far less than the predicted payout amounts of nearly $14 billion.

 

The settlement, which helps BP avoid a monster-sized trial in New Orleans federal court, could help speed payments to those affected and could be seen as a major step in putting the spill behind it. Through the Gulf Coast Claims Facility trust, BP has already paid out about $6.1 billion to compensate victims. The latest settlement will be in addition to that.

 

While the civil settlement is a major milestone, BP still has to face its toughest opponent yet: The federal government. Two U.S. government probes have placed most of the blame for the rig explosion squarely on BP, alleviating Halliburton (HAL) and Transocean (RIG) of much of their legal responsibility.

 

The Justice Department is set to begun its suit soon, with stiff pollution-law penalties expected. BP could still face as much as $17.6 billion in fines stemming from the Clean Water Act. The energy firm has set aside roughly $3.5 billion for potential environmental penalties.

 

However, the feds aren't the end of BP's legal woes. Five U.S. states, whose coasts were damaged by the spill, have also filed suit against the energy giant. In addition, many of BP's Deepwater Horizon partners, like Anadarko Petroleum (APC), have been jockeying with it over who should lay claim to the spill. These side battles certainly add pressure and take away assets from the main focus trial.

 

Finally, investors in BP shouldn't necessarily be too thrilled with the civil settlement. U.S. District Judge Carl Barbier, who in January ordered BP to uphold a compensatory-damage clause in its contract with Transocean, has to approve the $7.8 billion settlement. Given his hard-line stance toward BP already, it could yet be back to drawing board for the PSC and BP's lawyers.

 

So are the shares a buy?

 

Given the British energy giants legal woes, it's not surprising that it trades for a significantly lower valuation than many of its peers. As the price for crude has risen, many of BP's integrated rivals have seen their shares prices surge. Since the spill, shares of other majors like Conoco Phillips (COP) are nearly 40% higher. Despite its recent gains, BP still trades for about 15% below where it was at the day before the disaster in April 2010.

 

While that discount is tempting, it may not be enough. As BP has battled the spill and legal landscape, it's roughly two years behind its rivals in terms of exploration and production efforts. While a variety of other firms have begun to explore more unconventional assets and gain valuable reserves, BP has actually held asset sales to free cash.

 

Most recently, it sold its natural gas assets in Kansas to Line Energy (LINE) for $1.2 billion. So far, BP has disposed of assets worth almost $22.9 billion, less than half of the $50 billion it hopes to raise by 2014. By disposing of future cash-generating assets (those 2,400 wells could be quite valuable in a future filled with liquefied natural gas exporting), BP is seriously limiting its coming prospects.

 

So are BP shares a buy? As a small starter/satellite position, sure. Some analysts predict that BP could move about 25% higher on the recent settlement news. But as a long-term play, plenty of other energy majors offer stronger growth potential, better E&P prospects and none of the same legal liabilities. Investors would be better suited in any of them.

 

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

 

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