The Surprising Sell Case For BP Plc

Today I am looking at why I believe heavy oil price weakness is set to drive shares in BP (LSE: BP) (NYSE: BP.US) lower.

Oil price weakness looming ever larger

The implications of the 2010 Deepwater Horizon oil catastrophe in the Gulf of Mexico continues to dominate the headlines for oil leviathan BP. The company received a boost last week after a US court ruled that the firm should halt compensation payments to claimants who have not incurred “actual injury traceable to loss”. The material effect of this on the final bill will remain unknown until full judicial process is completed, a scenario that could take an age to resolve.

While this issue continues to dominate investor attention, I believe that the effect of collapsing oil prices in the meantime represents a very real threat to earnings. Indeed, the effect of lower oil prices was a significant factor in driving underlying profit to $6.9bn in the first six months of 2013, down from $8.2bn in the same period of last year.

BP advised that clean earnings per share in January-June were achieved with an average Brent crude price of $108 per barrel. But prices have receded steadily since then, and Standard Bank said that it expects Brent to average $107 in October-December and $106 in January-March. The broker added that subdued demand is likely to keep prices hemmed below $110 per barrel over the next year.

And I believe that prices could be sent shuttling lower in the near-term. Unimpressive data from China and Europe this week has again outlined the patchy state of the global economic recovery, while the enduring standoff on Capitol Hill — and likelihood of another temporary sticking plaster being applied to avert immediate economic catastrophe — could again push black gold prices heavily to the downside in coming months.

It has been argued that shares in BP are currently undervalued, the company’s stock price up around 3% since the turn of the year versus 11% for the rest of the UK’s oil and gas producer sector. Indeed, the oil giant was recently trading on a P/E ratio of 8.8 for 2013, based on the City’s earnings projections, comfortably below the value benchmark of 10.

But with oil prices at risk of fresh pressure in coming months, combined with the uncertainty that comes attached to the general business of fossil fuel production, the City’s earnings estimates for BP could come under heavy scrutiny. I believe that there is too much uncertainty hanging over the oil giant at the present time to categorise the company as a shrewd investment.

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> Royston does not own shares in BP.