The oil majors face a key challenge: Replacing reserves is becoming increasingly difficult for a company of BP's size. There is, of course, a lot of oil left in the world, but finding large amounts of new low-cost reserves remains a daunting task, in no small part because many governments now don't allow Western companies access to their resources.
BP's finding and development costs have been rising
Outside of Russia, BP (BP.) produced the equivalent of 860 million barrels of oil and gas in 2013; this represents the level of reserves it needs to book annually to prevent reserves from declining. But there simply are not this many barrels of conventional – that is, low-cost – oil and gas reserves annually accessible to BP. This has forced the majors to increasingly focus on higher-cost resources; deep water, oil sands, and shale gas, for example.
Therefore, at a given level of oil prices we'd expect BP's future returns to be lower, as nonconventional resources are typically costlier to develop and produce. This is one of the reasons BP's finding and development costs have been rising in recent years.
On the Macondo front, BP reached a $18.7 billion deal that will effectively settle all major remaining liabilities related to the oil spill. The key aspects of this deal; the settlement amounts, length of payment terms, were as good as investors could have hoped for. Once BP's SEC and criminal settlements finished being paid off in 2017, pretax Macondo cash outflows will fall to $1.1 billion per annum. A few pieces of litigation remain that could require additional payments, but these are minor in nature. All told, post-tax payouts related to the oil spill reduce our fair value by $4 per ADS, or 41p per share.
In Russia, BP's exposure now comes via a 20% stake in Rosneft, an investment that will provide much lower cash dividends than TNK-BP, its prior Russian venture, while being inherently riskier, given the government's large ownership stake. BP's Russian exposure is now lower than it was under TNK-BP, and its Rosneft stake accounts for 7% of our published valuation but less than 2% of future cash flows.
