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BP Plc (BP - Analyst Report) made its exploration objective clear with its decision to spend more on its Azerbaijan exploration activities this year. The U.K. major has boosted its capital spending by 23% to $3.2 billion from the 2011 level of $2.6 billion on its oil and gas projects in the region.

The BP-Azerbaijan AIOC group plans to invest the amount in the Chirag, Azeri and Guneshli (ACG) oilfields, which have estimated recoverable reserves of about 1 billion tons of oil in the Caspian Sea. Of the total budget, $708 million will be set out for operation expenses, while the remaining $2.5 billion is expected to be channeled for drilling approximately 12 new wells for the ACG project.

Last year, ACG generated oil volumes of 35.4 million tons from the Chirag, Central Azeri, West Azeri, East Azeri and Deepwater Gunashli platforms, lower than the 2010 level of 40.6 million tons as some drilling platforms were shut for overhaul. Although, SOCAR –– the Azeri state oil company –– forecasts oil production from the fields to be around 37 million tons this year, BP did not provide any such estimates.

BP holds the operational share of 35.8% in the ACG venture, while other partners include Chevron Corporation (CVX - Analyst Report) with an 11.3% interest, SOCAR (11.6%), INPEX (11%), Statoil ASA (STO - Analyst Report) with an 8.6% stake, ExxonMobil Corporation (XOM - Analyst Report) with 8%, TPAO (6.8%), ITOCHU (4.3%), and Hess Corporation (HES - Analyst Report) with a 2.7% interest.

Again, BP also expects to spend around $1.55 billion (up from $870 million in 2011) this year for the Shah Deniz gas field, the largest natural gas field in Azerbaijan. The total budget will comprise $211.5 million for operational expenses and the balance $1.34 billion will be used for the second phase of the project as well as the drilling of two new wells. In 2011, this major gas field produced 6.67 billion cubic meters of gas and 1.8 million tons of condensate as compared with 6.9 billion cubic meters and 1.9 million tons in 2010, respectively.

The Shah Deniz field is operated by BP with a 25.5% share. Other partners include Statoil (25.5%), SOCAR (10%), Total S.A. (TOT - Analyst Report) (10%), LukAgip––a joint company of Eni SpA (E - Analyst Report) and LUKoil––with 10% interest, NIOC (10%), and TPAO (9%).

Azerbaijan registered total oil and condensate production of 3.9 million tons in the first month of 2012 versus 4.1 million tons in January 2011. Natural gas output also dropped 20% to 1.6 billion cubic meters from 2 billion in the year-ago period. Hence, we believe the increase in capital outlay will provide a significant boost in BP’s Azerbaijan production profile. Additionally, the company’s focus on a string of upstream activities in high margin areas like the Gulf of Mexico, Angola, the North Sea, Brazil, Australia and India bode well for its future growth.

Nevertheless, the British oil giant faces considerable risk from a decline in natural gas processing margins and a drop in domestic oil and gas drilling and end market demand, which could lower the growth rate. Therefore, we see the stock performing in line with the broader market and maintain our Neutral recommendation.

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