Why Robert Dudley's BP Could Be Even Riskier

Robert Dudley, the man charged with righting BP (BP), won't sound a retreat. Despite the disastrous blowout in the Gulf of Mexico, BP will plunge even deeper into deepwater exploration. Dudley, who becomes the first American chief executive officer of the British oil giant on Oct. 1, will slim BP to its core strength: the high-risk, high-return search for oil and gas in demanding environments. That's the same strategy that led to the Gulf spill and turned outgoing CEO Tony Hayward into a pariah. It remains alluring because it can generate large profits for companies that avoid calamity. "The key to this industry is replacing earnings, and BP thinks they know how to do that in deep water," says J. Robinson West, chairman of consultant PFC Energy in Washington.

Dudley, 54, doesn't have much choice but to make the company leaner. He needs cash to reassure financial markets of BP's viability and to pay gigantic bills for the spill. Along with announcing Dudley's new role, BP on July 27 took a $32.2 billion charge for estimated future spill costs. That led to a loss of $17.2 billion for the second quarter. To raise cash, Dudley surprised investors with plans to sell up to $30 billion in production assets—triple the level company executives in May said they would divest. BP's oil and gas production will fall from 3.8 million barrels per day to about 3.5 million.

What's on the block are mostly old onshore or shallow-water fields such as Alaska's Prudhoe Bay, where output is declining. The sales will heighten BP's dependence on deepwater fields, which already account for about 18 percent of its output. Stripped of its plain-vanilla oil fields, BP will be closer to what Wall Street analysts have long wanted it to be: an aggressive exploration play dependent on big finds in deep water such as the coastal waters off West Africa and in the Gulf. That's why it is so important for BP to stabilize its key U.S. business. The Gulf accounts for 11 percent of its production; the oil it extracts there is among its most profitable.

Production Asset Sales

A company spokesman says management was happy over the $7 billion that Apache (APA), a mid-size company, agreed on July 20 to pay in BP's first round of asset sales. Those oil and gas properties constitute about 2 percent of BP's production. The price was more than double BP's in-house valuation of the properties. Hayward said the deal effectively valued BP's total exploration-and-production business at $350 billion—almost three times the company's depressed $119 billion market capitalization.

Dudley won respect for the coolness he displayed under fire in Russia, as head of BP's turbulent joint venture, TNK-BP. He got the nod to lead the entire company at least in part to placate U.S. politicians and dissuade them from barring BP from drilling in American waters. BP is the biggest player in the Gulf's deepest waters, and its future depends on being able to hold on to its position there. Dudley, who grew up in nearby Hattiesburg, Miss., has been in charge of the Gulf cleanup effort. He spent half of his career at Amoco before it was acquired by BP in 1998. "It's not our intention to exit the U.S., nor do we believe we won't be able to operate there," he said on July 27.

Fortunately for BP, other countries with deepwater reserves, such as Angola and Egypt, have thus far refrained from restricting the accident-prone company. Dependent as they are on oil and gas revenue, these states don't wish to disturb a lucrative relationship. Dudley even sees an upside for the company, which he said could wind up with "higher-quality assets and growth" from its reliance on higher-risk exploration. Says Gianna Bern, president of Brookshire Advisory & Research: "In the years to come they certainly have the potential to have higher profitability on a per barrel basis."

Still, that future could be difficult if Dudley, like Hayward before him, falls short on his pledge to strengthen BP's safety program. "There is no room for error here," says Oppenheimer & Co. (OPY) analyst Fadel Gheit.

The bottom line: A trimmed-down BP won't back away from risky deepwater drilling; the business is simply too lucrative.

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