Option Investor

BP, Beyond Petroleum

Printer friendly version

BP, one of the oldest integrated oil companies in the world changed their name from British Petroleum to Beyond Petroleum several years ago to shift focus to new forms of energy other than oil. It looks like they may need to change it again to Beyond Pain given the number of problems they are experiencing around the world.

In the U.S. their largest refinery in Whiting Indiana suffered a fire several months ago and was taken offline for repairs. While the majority of the plant was offline they decided to install some upgrades at the same time. It was estimated it would take 4-6 weeks. It has been several months now and a significant amount of production is still offline with no expected restart date. While other refiners are printing money producing gasoline to sell at record prices the Whiting refinery continues to limp along at a fraction of its capability. BP was forced to declare force majeure last week on purchases of Canadian oil in order to focus what capacity they had left on producing gasoline from light sweet crude. By refusing to accept any more Canadian crude this causes upstream suppliers to slow crude production or find alternate outlets.

You may remember the leak in the Alaskan pipeline several months ago that shutdown oil to the west coast for a month. That was a BP problem caused by shoddy maintenance. They are replacing 16 miles of pipeline as a result. About two weeks ago BP reported another leak in the same facility as the first and had to shutdown 100,000 bpd of production. That outage took nearly two weeks to correct.

About 4 weeks ago BP's longtime CEO, Lord John Brown, was forced to step down in disgrace after he made false statements to a court about a sexual relationship with a 27-year-old male student. He forfeited about 15 million pounds in compensation as a result of the termination. Last Wednesday BP announced that the head of their refining division had quit to accept the CEO position at Talisman Energy.

The $1.5 billion BP platform Thunder Horse was nearly sunk by the hurricanes and required hundreds of millions of dollars in repair and refit expenses. Once replaced on station in 6000 feet of water in the Mississippi Canyon Block in the gulf additional problems arose requiring reengineering of several components. Thunder Horse was supposed to begin production in 2005 and now that production has been delayed until the end of 2008. Thunder Horse expects to produce 250,000 bpd of oil and 200 mmcf per day of gas. That is roughly $17 million a day in revenue that was supposed to come online in the fall of 2005. Instead of revenue they have been pouring money into the project in what seems like a bottomless pit. The new CEO Tony Hayward said production from Thunder Horse will eventually happen. "Thunder Horse is something that has not been done before and we probably pushed the technology envelope a little bit too far."

As big as all of these problems are they pale in comparison with the one they have this week. BP is about to lose a $20 billion investment in the Kovykta gas field in Russia. BP developed the field with plans to use the field for gas exports to China. Last year Russian authorities began their attack on BP in order to return the project to Russian ownership just like they have to all the other major energy projects owned by non Russian entities over the last five years. The Kovytka project is the last major project owned by outsiders and that will be rectified next week. Russia has found a way to seize control of these projects that appears perfectly legal but is nothing but pure government snatch and grab.

For other projects like Shell's $20 billion Sakhalin II gas project they "found" environmental violations that required the government to terminate their operating license. No license, no production, no revenue and no way out. Shell's Sakhalin project along with a handful of other projects have all been returned to the state or to Russian controlled companies. Exxon recently invested $60 million to explore off Eastern Siberia only to have production rights to the newly discovered oil given to a Russian company leaving Exxon out in the cold.

With the BP's Kovykta project they found another ploy to cripple BP and return ownership to the state. Remember, Kovykta was developed to export gas to China. Once completed Russia, through its government owned gas export monopoly Gazprom, banned any exports from Kovykta to China since Gazprom has its own rival project to supply China. If you can't get top dollar for your gas then eliminate the competition. BP was forced to curtail production severely to supply only local needs at a fraction of potential. Russia then said it was going to revoke BP's operating license due to "under production" at the field. That is an amazing strategy for Russia. Russia allowed BP to invest $20 billion to develop a field for export outside Russia and then ban exports once completed. Russia then cancels their license for lack of production and BP can kiss their investment goodbye.

IIn other cases the operators like Shell hoped to recover some of their investment by retaining a minority ownership after relinquishing control to the various Russian entities. In the case of BP they tried to recover some of their investment by ceding control to Gazprom and retaining a minority interest. Gazprom refused saying they had no interest in the field. What energy company, even a government-controlled entity, would have no interest in a $20 billion project with enough gas to supply the entire world for a full year? It is ludicrous at best. It is simply a ploy for the Russian state to take full control, kick BP out and then transfer the project to Gazprom or Rosneft for pennies on the dollar.

The revocation of the license was expected to be announced last week but that was postponed until after this week's G8 summit and its landmark economic forum. It is not easy to announce you nationalized a $20 billion project and then have to go make nice with your peers from truly capitalistic countries. It might make for some uneasy questions over dinner. By not announcing a decision they can still say they are working on a plan and not have to face condemning statements for taking action. Once the G8 meeting is over Russia can boot BP from Kovykta with a two-line announcement and then sweep it under the rug to be forgotten just like the prior thefts of other projects.

Russia is the second largest oil producer on the planet at 9.6 mbpd and has the largest gas reserves, nearly double Iran at the number two spot. As the largest energy producer in Europe it has recently shown it plans on using its energy to exert increasing control over its neighbors. Russia needs the money but it also knows the exports are critical for survival to the consuming countries. They are in the drivers seat and they know it.

While it seems BP has been cursed there have been some positive developments. BP just announced a new project in Libya where it will invest $2 billion to search for natural gas in a 35,000 square mile region. The exploration phase will take seven years followed by a substantial investment to build out infrastructure to transport production with commercial production not expected until 2018. BP believes there are significant reserves of both gas and oil in the region and more than enough to justify the investment in time and money.

Despite the bad news BP stock refuses to die and continues to trade sideways between $65 and $70. I believe the loss of the Kovykta field in Russia is already priced into the stock but I would not be a buyer until after the official announcement, if at all. There are better plays. Because of the new Russian confiscation schemes I am also avoiding ConocoPhillips (COP) despite its strong trend. COP owns a 20% stake in Lukoil and that $20 billion stake could be erased with the stroke of a pen. For integrated oils Chevron and Marathon are better choices today. I also avoid ExxonMobil because of the large share base of more than 5.6 billion shares. That prevents it from making strong moves even though it is the most diversified and has the largest reserves.

Late Saturday the FBI reported it had charged four people with plotting to attack JFK airport by blowing up the 40-mile long Buckeye fuel line, which is the main source of fuel for the airport. The targeted section would have been between Linden, NJ and JFK. The terrorists were quoted as saying they expected to cause greater destruction than 9/11, kill several thousand people and destroy a large part of the Queens borough where the line runs underground through the city. One terrorist, Abdul Kadir, was a former member of Parliament in Guyana but left his post last year to plan this attack. Cutting off fuel supplies to JFK would be seriously detrimental to the U.S. transportation network and severing the pipeline in an explosive maelstrom consuming millions of gallons of jet fuel could have taken weeks to repair.

For next week I believe oil prices will continue to wander between $63-$68 without a major event to push up prices. Friday marked the start of hurricane season and right on cue tropical storm Barry appeared in the gulf with 60 mph winds. It quickly moved over upstate Florida and back into the Atlantic with mo impact on the oil patch. As the second named storm of the year it was just another warning that hurricane season is here and we could easily be talking $75 oil very quickly if one appears headed for the oil patch. This will be an environment where few traders will want to be short crude and that will take away a lot of the volatility.

We are nearing our planned exit on many of our energy plays. Oil prices typically decline as summer draws to a close, driving demand slows and hurricane season winds down. We want to exit many of our positions on any late summer storm generated spike and then prepare to enter new positions on the fall dip. The chart below shows that Sept 10th is the normal peak of hurricane season and therefore a likely peak in oil prices.

Hurricane History Chart

I sent out a note on Wednesday suggesting we exit the play on Apple. Apple was trading at $118 when I sent the email. After running up nearly $20 from our entry we had over $11 profit in the LEAP. The play concept was to capture the expected excitement prior to the release of the iPhone and we did that. I was afraid that any news of a delay in the release, technical problems or just the release itself on June 20th could produce a significant sell the news event. Better to take profits now and let others capture the risk.

Jim Brown

July Crude Futures Chart - Daily

July Gas Futures Chart - Daily

July Gasoline Chart - RBOB Daily


Leaps Trader Commentary Archives