BP’s future, and Big Oil’s: Fewer, bigger bets

BP is going to emerge from the Deepwater Horizon disaster more or less intact — but how it does so may suggest a more streamlined future for Big Oil as a whole.

BP has begun a serious house-cleaning. It has swept out CEO Tony Hayward, replacing him with an American successor, Bob Dudley. Then, after a terrible second-quarter earnings report, the company announced a tripling of asset sales, to $30 billion from $10 billion.

This last change isn’t just a measure of BP’s unique problems — it’s part of a new industry trend. Call it the shrinking of Big Oil.

The usual oil-patch narrative holds that the majors are being squeezed out of the world’s best oil basins by state-owned national oil companies, and being forced to drill expensive, higher-risk projects such as the deep water well in the Gulf of Mexico that got BP in so much trouble. But this narrative is superficial to say the least — those risky projects can generate much greater returns than continued extraction from mature oilfields. So the companies are selling their languishing fields and focusing on long-term properties with the biggest upsides — they’re making fewer, bigger bets.

In this vein, as Jad Mouawad and Clifford Krauss write at the New York Times, BP is moving in a substantially different direction after leading the industry’s two-decade-old, size-is-everything merger mania. On the one hand, BP’s sale of $7 billion worth of properties in Canada, Egypt, and the U.S. to Apache is an admission "that other companies can squeeze more value out of their assets than they can," says Ed Chow, a former Chevron executive and senior energy fellow at the Center for Strategic and International Studies. Yet it also says that, while size is still crucial, trimming is a good thing. "Leaner and meaner usually means more efficient and profitable," says Oppenheimer & Co. analyst Fadel Gheit.

The other main advocate of this approach is ConocoPhillips. After a buying binge left it with a $17 billion loss in 2008, Conoco started a $10 billion asset sell-off that’s only accelerating. Last week, Conoco announced that it isn’t selling half of its stake in Russia’s Lukoil, as it had previously announced; now it’s selling all of it. As Bloomberg’s Nidaa Bakhsh writes, Conoco has also placed a German refinery on the auction block. The decisions reflect a strategy of "shrinking to grow," says Deutsche Bank’s Paul Sankey. Shell has also joined the divestiture game, announcing asset sales last week of $8 billion.

Exxon Mobil and Chevron are under pressure to follow. Both delivered robust quarterly earnings reports last week. But as the Wall Street Journal‘s Liam Denning pointed out last Thursday, investors are skeptical of the old growth-through-acquisitions strategy. Case in point: Exxon’s share price has plummeted since its purchase of shale gas giant XTO Energy last December. In a note to clients Friday, Deutsche Bank’s Sankey suggested that Exxon could listen to some of BP’s wisdom: "If anyone wants to go long oil, [the super-majors] offer less upside leverage than smaller names…We continue to believe Big Oil should do more to divest assets and shrink."

And take risks. The biggest money remains in high-risk prospects such as deepwater drilling in Angola, Brazil, West Africa and, of course, the Gulf of Mexico. In a note to clients Friday, Oppenheimer’s Gheit wrote that Wall Street has rewarded the slimmed-down Conoco, pushing its share price up 7 percent this year, compared with a 12 percent average decline for its peers and a negative 2 percent return for the S&P 500.

The Financial Times‘ Lex column has expressed uncertainty before on the continued viability of Big Oil’s "super-major" model, so I e-mailed to ask what its writers think about the latest news. Vincent Boland responded with caution about jumping to conclusions on a new industry trend of slimmer companies. "I think it is too early to say whether BP will be a better company as a smaller company," he said.

But for BP, the planned sale of some 10 percent of its assets appears to be less a move of desperation than of gaining tactical and strategic flexibility. In the near term, despite its $17 billion loss last quarter, BP seems to be in reasonable shape, with one of the industry’s most enviable portfolios of properties, ranging from Angola to Russia. The cash buildup will allow it to weather a worst-case scenario should liabilities from the Gulf of Mexico spill grow larger.