To BG and Not BP, That Is the Answer

In the tale of two U.K. energy companies Tuesday, there was only one winner.

Natural-gas-focused BG Group and oil company BP both reported higher first-half earnings, thanks to high prices, even as output fell. There the similarities end. The contrast between the two, reflected in BG’s shares rising 3.2% and BP’s falling 2.4%, is set to get starker.

BG’s magic ingredient is growth. Brazil, in particular, is a gift that keeps on giving. BG last month doubled its estimated reserves in the Santos basin to six billion barrels of oil equivalent. Even without those extra reserves, BG had expected 6%-8% annual production growth from 2012 to 2020, with major projects also in Australian liquefied natural gas and U.S. shale gas.

BP, meanwhile, is struggling to replace lost production from the Gulf of Mexico. First-half production would have fallen 7% year on year, even if BP hadn’t had to dispose of several assets since last year’s oil spill. A supposed breakthrough plan to drill for oil off Russia’s Arctic coast already has run aground this year.

With BG trading at 15.1 times expected 2012 earnings, compared with BP’s six times, such differing prospects may look fully priced in. Still BG, like BP, trades at a discount to the net present value of its reserves, a gap of 19% in BG’s case, according to Macquarie, including the upgraded Brazilian reserves estimate and assuming a long-term oil price at $88 a barrel.

BG’s improving production performance may help soothe nerves about its ability to realize its reserve potential: Output rose 2.7% year on year in the second quarter after a 5% decline in the first three months of 2011. A quicker way to close the valuation gap would be for BG to consider some shrinkage, though nothing as radical as a full breakup that some think makes sense for BP.

BG could sell part of its stakes in three Brazilian oil fields, helping to prove their value and allay concerns the company may not have the capacity to develop its share of the fields. Still, BG boss Sir Frank Chapman is adamant the company has enough financial and human resources to pursue the project. BG’s track record to date suggests he deserves the benefit of the doubt.

By Andrew Peaple, Dow Jones & Company

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