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BP Pays Penance, Feeding Plains’ Plans

BP (NYSE:$BP) has decided to sell its $5.6 billion Gulf of Mexico assets to Plains Exploration (NYSE:$PXP) in a further move to cover $38 billion in damages arising from the Deepwater Horizons disaster.   The assets include several deep water fields with daily production of 59,500 barrels. The London based oil giant has so far sold $32 billion in assets but is planning on keeping its most profitable assets.

BP’s case is still pending in US courts. The government lawyers are trying to prove that the incident was a direct result of its ‘gross negligence’. If the court sides with the government, nearly a slam-dunk in U.S. Federal courts where prosecutors have a 95% conviction rate, the fines for BP alone could reach $18 billion.

However, the company will maintain significant position in Gulf of Mexico as it currently has four production plants and six exploration rigs hunting for more wells while it plans to invest $4 billion annually until 2030 in the region. BP’s top management believes that if it pursues this strategy it will not have to sell any of its more profitable ventures such as Atlantis, Mad Dog, Thunder Horse and Na Kika. By the end of the current year, BP will have eight rigs in Gulf of Mexico, which will be its highest rig count ever in the region. BP also acquired 43 new leases in the Gulf of Mexico in an auction held three months ago, bringing its total in the region to more than 700 leases.

The deal was larger than RBC Capital Market’s estimate of $2.2 billion working under the assumption of 50,000 barrels of daily production backed by eight years of reserves. Analysts think that BP has bagged themselves a good deal here and Plains Exploration’s investors agreed. The company’s shares fell by 10.4% until Tuesday following the announcement while BP’s rose by 1%.  Obviously, global unending QE wasn’t part of the analyst’s models. 

The deal will give a major boost to Plains Exploration’s crude oil output which should triple its production. Plains has other production facilities in California, the Gulf Coast and the Rocky Mountains.

Plains Exploration has struck another deal in early September when it agreed to purchase 50% stake from Shell Offshore Inc., a subsidiary Royal Dutch Shell (NYSE:$RDS), in the Holstein Field for $560 million.

With a market cap is just ~$4.7 billion while facing a price tag for both of the deals is $6.1 billion, Plains will finance the BP deal through six banks including JPMorgan Chase (NYSE:$JPM) and Bank of America (NYSE:$BAC). This heavy leverage makes them very susceptible to any downward spike in oil prices. But the company is not planning to stop there.  It is following a leveraged-buyout strategy whereby it will increase its asset base and multiply its daily output. CEO James Flores is planning to increase its debts to $10 billion by the end of the year.

Once the acquisitions are complete, cash from operations handle debt refinancing. Plains Exploration is aiming to compete with the big boys of the oil industry and analysts believe that its strategy, albeit risky, is the only way forward towards its objective. 

Plains is a growth stock play that is predicated on the demand for oil continuing to rise.  I expect the price to be supported now long-term by open-ended QE in the West and rising demand and falling relative prices in the East.  But in this environment I would be loath to commit a lot of capital, so buying long-dated out-of-the-money calls is a lower-risk investment strategy, rolling them forward in time if profitable and liquidity enters the market.

It is hard to recommend BP at this point with the threat of a U.S. Government lawsuit hanging over its head when there are better plays in the sector among the majors, like Exxon-Mobil (NYSE:$XOM) who has built a great natural gas portfolio buying when there was blood in the water.

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Peter Pham is an author, international fund manager, and a registered financial director by the Cayman Monetary Authority (CIMA). In 2013 he published his first book entitled, The Big Trade: Simple Strategies for Maximum Market Returns. He currently manages the portfolio of a global hedge fund and runs an asset management company, Phoenix Capital.  (read more)

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