The Biggest Threat to BG


I like BG Group (ISE: BG.L) . The FTSE 100 (UKX) natural gas group is in a growth industry, and its integrated business model -- with its own liquefaction plant and shipping operations -- means that it can ship its liquefied natural gas to the highest value markets.

And it has been a highly successful explorer, with production in more than 20 countries, but now the company risks being the victim of its own success.

The company's early entry into Brazil's offshore Santos Basin means that it is the only foreign operator to have stakes in all five of the exploration blocks in an oil and gas field anticipated to match the North Sea at its peak within a decade. BG expects 40% of its production to come from Brazil by 2020.

To fund development of these discoveries, BG is selling downstream assets. It has raised a total of $4 billion and is on track to achieve its target of $5 billion in sales when it delivers its annual results next February.

Now the City has got into its head that the company is overexposed to Brazil.

Credit Suisse sounded a warning in July, highlighting that cost overruns and project delays could upset BG's growth targets. Then last month, analysts at Jeffries suggested that the company either needed to break itself up or seek a merger partner. It thinks the group is overly reliant on Petrobras, the Brazilian state-owned oil company that is the operator on all of BG's interests. Jeffries argues that BG should either reduce its exposure by selling some Brazilian assets, or merge into a larger organization.

That's had a direct impact on the shares, which are down 5% over the year, underperforming the FTSE 100 by 10%.

It's easy to find confirmation of their fears. Just the fourth paragraph of CEO Sir Frank Chapman's half-year review tells investors that Petrobras "presented its latest business plan, which confirmed its commitment to the fast-track development of the first-phase of our joint interests in the pre-salt Santos Basin, in line with BG Group's own plans."

It is extraordinary how dependent the company is on Petrobras' business plan. BG is doubly exposed in Brazil: to the political risk of changes in taxation or regulation that would hit its returns, and to the operational delivery and performance of Petrobras.

The City's faltering confidence in what was a stock market star comes at an unfortunate time for management. Sir Frank Chapman, who is credited with the company's transformation, is to step down next June after 12 years. There are countless examples of star performers that falter after a long-serving and highly respected leader departs. Most recently, Tesco (ISE: TSCO.L) comes to mind.

Intriguingly, The Sunday Times speculated that chairman Andrew Gould has sounded out Sam Laidlaw, the CEO of Centrica (ISE: CNA.L) as a possible replacement. He moved that utility into upstream assets, and has a background in the oil industry. A new broom might well signal a major change of direction for BG.

And unfortunately, BG's finance director has recently been granted leave of absence to undergo medical treatment. It was a shrewd move to appoint the well-connected Brazilian Fabio Barbosa, who previously worked in Brazil's finance ministry, and his absence leaves a gap in BG's management.

The main chance is still that BG will bring its Brazilian fields into production. That makes it the great long-term growth prospect that many still believe in, and this year's pullback is a buying opportunity. Though the shares are not cheap in the current market, the price-to-earnings ratio of 15 is at the lower end of its historic trading range.

The potential up and down sides are even more exaggerated at BP (ISE: BP.L) , whose Russian joint-venture is subject to a form of Russian roulette. By contrast, Shell (ISE: RDSB.L) is a more diversified business.

This just underlines that oil and gas companies can be risky investments and it pays not to put all your eggs in one basket. The Motley Fool's new report "How to Unearth Great Oil and Gas Shares" tells you more about how to build a portfolio in this sector. It's free, and I recommend you download it to your inbox by clicking here.

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Tony Reading owns shares in BG, Shell, and Tesco but no other shares mentioned in this article. The Motley Fool owns shares in Tesco.The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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