July 27, 2018 / 11:47 AM / 20 days ago

Breakingviews - BP takes worthwhile gamble with shale deal

LONDON (Reuters Breakingviews) - BP is bucking the trend. Oil investors nowadays are sceptical of pricey deals that double down on hydrocarbons. The UK oil major’s $10.5 billion acquisition of BHP’s U.S. shale assets, announced on Friday, superficially ticks those problematic boxes, but is still worthwhile.

Logos of BP are on display at a petrol station in Moscow, Russia, July 4, 2016. REUTERS/Sergei Karpukhin - RTX2JXZN

On the face of it, BP is paying up. The price is just above the $8 billion to $10 billion range that analysts had estimated assets in the Permian, Eagle Ford and Haynesville basins of Texas were worth. And the implied value of the land is around $22,000 per acre, above the $18,632 average for recent Permian transactions, as calculated by broker Raymond James.

Still, Concho Resources offered more than $100,000 per acre in March for RSP Permian. And BP reckons it can achieve $350 million in annual synergies given it already owns oil and gas fields in the region. Taxed at 30 percent and capitalised, these are worth $2.5 billion. That implies BP is paying $8 billion, or $17,000 per acre. Moreover, the company thinks the $10.5 billion price tag can be achieved by discounting the assets’ future value at 10 percent and assuming an oil price of $55 a barrel. As long as crude values hover above $70 a barrel, the price looks cheaper.

BP investors have two other reasons to feel sanguine. First, the company has been underexposed to the hottest market in global oil since the sale of its U.S. shale assets in 2010. Adding the equivalent of 190,000 barrels of oil per day to production may seem small beer against 2017 annual output of 3.6 million barrels per day. But shale production cycles are much shorter than those of traditional oil projects, so these assets are more likely to be exploited before oil demand peaks.

Second, BP’s balance sheet is healthy enough to take the strain. While it will use cash reserves to pay half of the $10.5 billion, it could well generate $5 billion in both 2019 and 2020 after accounting for capital expenditure and dividends, according to Jefferies analysts’ estimates. An equity hike will pay for the rest but will be neutralised by a buyback, itself funded by asset disposals.

BP investors are aware that BHP spent $30 billion trying to make the most of the assets before today’s deal, and had to swallow a final $2.8 billion writedown on Friday. But the logic behind the oil major’s own deal is sound.

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