Earlier this year, BP (LSE: BP) (NYSE: BP.US) and Royal Dutch Shell (LSE: RDSB) (NYSE: RDS-B.US) traded on near-identical valuations, as markets seemed to forget about BP’s US woes.
Events in Ukraine, and the resultant US and EU sanctions, soon put an end to this, hitting BP’s share price, while leaving Shell’s almost untouched:
| BP | Shell | |
| Share price since July 1 | -7.7% | -1.6% |
| 2014 forecast P/E | 9.8 | 10.9 |
| 2014 prospective yield | 5.1% | 4.5% |
As these numbers show, the market has now applied a modest discount to BP, to reflect the greater financial, operational and reputational risk attached to the firm. The most immediate risk is the impact of western sanctions against Russia.
How could sanctions affect BP?
BP’s main exposure to Russia is through its 19.75% stake in Russian oil giant Rosneft, which is already reported to have asked the Russian government for a $42bn credit line, to help it refinance its debt, as sanctions now prevent Rosneft from accessing US dollar credit markets.
Here’s how Rosneft contributed to BP’s finances during the first half of this year:
| BP’s Rosneft stake | Value during H1 2014 |
| Contribution to pre-tax profits | $1.5bn |
| Dividend (cash) income | $693m |
The numbers look impressive, but it’s worth noting that while Rosneft contributed around 10% of BP’s pre-tax profits, it only contributed about 4% of BP’s operating cash flow.
In other words, BP’s ability to operate — its cash flow — is unlikely to be affected by the Russian sanctions, even if Rosneft’s profits fall dramatically, and it’s forced to cut its dividend payout.
What about Shell?
Shell does have operations in Russia, principally at Sakhalin, where it has a 27% interest in Russia’s only current LNG gas export facility, which is run by Russian firm Gazprom.
The Anglo-Dutch firm has stayed quiet so far on the potential impact of the most recent round of sanctions, which restrict Russia’s access to western oil and gas technology, but some reports have suggested these restrictions won’t impact Shell’s gas operations as much as they will those of oil-focused Rosneft.
Buy BP or Shell?
Both companies may find they are unable to enter into new projects in Russia until sanctions are lifted, but ultimately, this will only be a short-term problem, compared to the multi-decade scale that’s typical of large oil and gas projects.
There’s no doubt that Shell is currently having a better year than BP, but Shell’s share price has risen strongly so far this year, and I’m beginning to think that BP’s 5%+ yield is more attractive, and provides adequate compensation for the extra risk the firm currently carries.
