This week’s second-quarter results from BP (LSE: BP) (NYSE: BP.US) make it clear how much Russian firm Rosneft is already contributing to BP’s profits: during the second quarter of this year, BP share of Rosneft’s earnings was $1,024m — 20% of BP’s total pre-tax profits for the period.
The problem is that Rosneft isn’t a normal company — and it faces a number of unusual problems.
Do you need to worry?
BP shares have fallen by nearly 5% over the last month, as the market has gradually factored in the reality that state-owned Rosneft is one of the top targets of western sanctions against Russia.
Although it’s too early for BP to have suffered any significant effects from current sanctions, more severe sanctions are expected to be announced later this week, and BP warned investors today that further sanctions could hurt, saying:
“Any future erosion of our relationship with Rosneft, or the impact of further economic sanctions, could adversely impact … the level of our income, production and reserves …”
$50bn headache
Although sanctions pose the most immediate threat to BP’s Rosneft profits, the longer-term risks posed by this week’s Yukos ruling could be much worse.
Rosneft, which is 75%-owned by the Russian state, purchased most of Yukos’s assets when it was forced into administration. However, on Monday, an international court ruled that former Yukos shareholders should be paid $50bn in compensation by the Russian government.
If Russia refuses to pay, as seems likely, then Rosneft assets outside Russia could be targeted for seizure. The value of BP’s stake in Rosneft could fall dramatically — potentially to zero.
Buy or sell BP?
Alongside all of this, BP shareholders will have to wait until at least next year to find out how much their company will have to pay in damages for the Gulf of Mexico oil spill.
Although I’ve previously been bullish on BP, and willing to disregard the risks posed by its involvement in Russia and the Gulf of Mexico oil spill, my view is changing.
Russian risks have risen significantly in recent months, and I now feel that BP shares deserve a meaningful discount to those of Royal Dutch Shell.
BP shares currently trade on a 2014 forecast P/E of 10.2 and a prospective yield of 4.8%, compared to 11.5 and 4.4% for Shell. I suspect this discount may yet widen further, and would not rush to buy more BP shares at this price.