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3 Alarming Reasons To Avoid Investing In BP plc

bp

Today I am looking at why I believe the risks continue to outweigh the potential rewards at oil giant BP (LSE: BP) (NYSE: BP.US).

Courtroom complications adding up

Any report on BP wouldn’t be complete without addressing the impact of the ongoing Deepwater Horizon saga. The company reported earlier this month that total cumulative costs have risen by $200m to $42.7bn, and that the final bill could still exceed this figure.

This is not the only courtroom battle the oil giant is having to fight, however. Just last week, a US appeals court ruled that stakeholders can proceed with claims of securities fraud relating to an Alaskan oil spill in 2006. Although BP claimed that the incident — which saw 200,000 gallons spill into Prudhoe Bay — was a one-off, “facts alleged in the complaint support the conclusion that BP had been aware of corrosive conditions for over a decade, and yet chose not to address them,” the court said.

Asset sales constricting output prospects

The massive cost of these seemingly never-ending legal battles continue to weigh heavily on BP’s financial performance. The company announced in this month’s final results that underlying replacement cost profits has slumped 27% in 2013 to $13.4bn, with the effect of project divestments to cover legal expenditure — as well as rising production costs and challenging refining conditions — weighing on the bottom line.

A lower asset base pushed 2013 group output 3% lower, and BP warned that this problem, combined with an expired production deal in Abu Dhabi, is likely to push output still lower in 2014. Indeed, with the company planning to divest a further $10bn worth of projects by the end of next year, the firm’s production — and subsequently earnings — potential looks much weaker in coming years.

Cash flow forecast under attack

BP says that it hopes to achieve net operating cash flow of between $30bn and $31bn this year at a projected average Brent crude price of $100 per barrel. But as Investec points out, the business didn’t come close to achieving the profits last year which would support this target, even with prices averaging $108 a barrel.

With BP’s cash pile likely to come under heightened pressure, particularly as a glut of supply is set to hit the oil price in coming years, concerns abound over whether the oil leviathan can keep its progressive dividend policy running at the breakneck pace of previous years.

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> Royston does not own shares in BP.