BP Upgraded to Neutral

We have upgraded our recommendation on U.K. oil giant BP plc (BP - Analyst Report) to Neutral from Underperform. The company operates in three segments: Exploration and Production, Refining and Marketing, and Other Businesses and Corporate.

BP maintains a leadership position among the global offshore drillers despite the oil spill in 2010. The company obtained 43 new drilling leases in Gulf of Mexico (GoM) in June 2012. BP plans to strengthen its Gulf operations with around four large production hubs and is likely to employ eight oil rigs in the area by the end of 2012. The company has major project ramp ups underway in Atlantis and Mad dog, which will likely boost output when these fields come online by third quarter 2012.

In 2012, BP expects organic capital expenditure to be around $22 billion. This bodes well for the company’s future as it will be beneficial for the expansion plans and help in increasing revenues. The availability of gas in the Taurt North and Seth South discoveries in the North El Burg Offshore Concession and the winning of two deepwater exploration and production blocks in Trinidad and Tobago are recent examples of organic growth.

Additionally, the company’s strategy of offloading its non-core upstream properties will prove beneficial over time while creating a portfolio with potentially stronger growth from a smaller base.

BP expects deepwater segment to form an important component in attaining its business strategy. During second quarter 2012, BP commenced production at Galapagos in the GoM and Clochas-Mavacola in Angola. The company intends to bring online another six projects by 2012 end. BP expects final investment decisions in over 10 new projects between 2012 and 2014. BP intends to complete exploring wells in Angola, Brazil, the North Sea and Namibia in 2012.

However, we remain apprehensive following BP’s weak second-quarter performance. The company’s earnings missed our expectation due to weaker-than-expected results in Upstream, TNK-BP and Downstream segments. Upstream and TNK-BP earnings were affected by lower realizations, and lower contributions from lubricants and petrochemicals operations hampered Downstream earnings.

BP also projected a lower production level for the year on a year-over-year basis. The GoM spill in 2010 and the failed Russian Arctic deal have undoubtedly weighed on BP shares.

BP, which recently disposed the Carson refinery in California to Tesoro Corporation (TSO - Analyst Report), carries a Zacks #3 Rank (short-term Hold rating).