Most gamblers will try to double down when they are in the hole. After all, if you’re already losing, that Hail Mary pass could be what saves you. For investors in international energy giant BP plc (ADR) (NYSE:BP), that Hail Mary comes from the segment of the market that put it in the hole in the first place.
We’re talking about deepwater drilling in the Gulf of Mexico.
BP has once again started to stake its fortunes on some pretty big developments in the Gulf’s deepwater. If BP is successful, it could just save itself from the lingering effects of the Deepwater Horizon spill and its nasty clean-up expenses.
If it fails, investors could be looking at the real beginning of the end for BP.
A Case of Déjà Vu for BP
Odds are, if you lost a ton of money in a certain sector of the market or business, you wouldn’t dive right back in and try it again, especially not when it created the worst oil spill in history and left you on the hook for nearly $61 billion in total legal fees, fines and clean-up costs.
But, if you’re BP, that’s exactly what you do.
Over the last few years, BP has continued to set-up its deepwater game and is now one of the biggest players back in the region. But, BP isn’t just moving back into the Gulf, it’s making it a cornerstone of the company’s future. Through 2021, the energy company is calling for more than $17 billion in annual investments to tap the Gulf and its deep-sea riches.
The bulk of that spending will be placed in four fields — Thunder Horse, Atlantis, Na Kika and Mad Dog — in the Gulf’s deepwater region. And, thanks to technology, BP now estimates that these four fields hold a combined 1 billion barrels of oil.
That’s worth about $40 billion at today’s prices.
This amount of money is nothing to sneeze at, and for BP it could be a life saver. After all, the costs related to the oil spill have significantly harmed the company and continue to cause issues. Last year, BP generated $17.8 billion of underlying operating cash flows with oil averaging around $45 per barrel. That easily covered its operating costs.
However, that backs out a slight caveat, namely spill-related costs. Throughout 2016, BP sent $7.1 billion out the door with regard to spill payments. Those payments should come to around $5.5 billion this year and $2 billion in 2018. Back those in and you’re looking at some negative cash flow numbers.
And, while the spill costs won’t be here forever, you can understand why BP has taken a shine to the Gulf and the potential payday associated with a billion-barrel oil find. In the end, it’ll make BP stock stronger and able to cover its “scary high” dividend.
BP Is All Alone
The problem for BP is getting all of this to work. The energy giant estimates that these fields will be profitable with oil in the $40’s. While management has been able to pressure oil service companies to lower costs, I’m not sure that they can do it. You know who else isn’t sure? Every oil company on the planet.
BP’s three chief rivals — Exxon Mobil Corporation (NYSE:XOM) Chevron Corporation (NYSE:CVX) and Royal Dutch Shell plc (ADR) (NYSE:RDS-A) — have kept already-running Gulf operations pumping crude. However, none of them have started new projects in the region. Meanwhile, smaller Gulf operators have fled in spades. Freeport-McMoRan Inc (NYSE:FCX) nearly filed for bankruptcy on the weakness of its Gulf operations, while Devon Energy Corp (NYSE:DVN) sold off its Gulf assets for a song.
Perhaps the most telling was independent E&P giant Anadarko Petroleum Corporation (NYSE:APC), which recently wrote down several of its projects in the Gulf when oil was still at $50 per barrel, with CEO Al Walker saying, “In a $50 to $60 world, we always felt like greenfield development, in the Gulf in particular, was fairly challenged.”
Heck, even BP only a few years ago was saying that it needed $100-per-barrel oil to warrant new Gulf development.
A Major Win or Loss for BP
There’s plenty of risk for BP in its deepwater ambitions, perhaps even more so considering that oil prices are once again heading south. Whether or not BP can really make a profit at $40 per barrel for deepwater drilling remains to be seen. And, with prices now dropping to that level, BP will be facing a real test out of the gate.
What’s worse is that BP has pretty much ignored the low-cost play of shale energy to focus on deepwater while XOM, DVN and other rivals have abandoned the Gulf, moved onshore and dug deeper into places like the Permian or Eagle Ford. BP is strangely absent from those spots. That could come and severely bite it in the tuchas if things don’t pan out right.
However, if successful, this could truly mean a new era for BP and an end to all its woes. $40 billion worth of potential is amazing, but it’ll take a lot of things to go right for that to happen.
The Bottom Line on BP Stock
A renewed 100% focus on deepwater drilling is something BP stock investors need to really consider when pulling the trigger. It’s a big gamble and investors need to consider that when looking at shares. For those portfolios still stinging from the Deepwater Horizon tragedy, it may hit too close to home.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
