Why BP is not a takeover target

Some in the industry see BP as fresh deal meat following the company’s long-awaited settlement with U.S. authorities in connection with the Deepwater Horizon oil spill. But while such a mega-merger may make Wall Street bankers salivate, even after selling off billions of dollars in assets, BP simply remains too big and too risky to buy. Specialization is the name of the game these days in the oil patch. BP would need to break up into more manageable pieces before any oil major would consider opening its wallet.

It seems like every two years or so there is talk that BP, arguably the most battered of the world’s “Supermajor” oil companies, is the focus of deal chatter. The last time this happened was back in January of 2011, when Shell was rumored to be interested in buying up its cross-channel and cross-town rival, creating a company with enough heft to take on the likes of the world’s largest publicly-traded energy company, ExxonMobil. Two years before that, it was ExxonMobil looking to buy up BP’s fledgling refining business. And two years before that it was talk of a possible merger-of-equals with Shell.

Like clockwork, unnamed sources (or chatty British bankers?), told Bloomberg News last week that BP may yet again be a takeover target. The reason BP is such a tasty morsel now? Its beat-up valuation just looks too irresistible now that the company has slimmed down and settled its differences with the U.S. and Russian governments.

In the U.S., BP recently announced a $4.5 billion criminal settlement with the Justice Department concerning its negligence in the massive oil spill in the Gulf of Mexico. And in Russia last month, after years of strong-arming by the government and controversial Russian oligarchs, BP agreed to sell its turbulent Russian partnership, TNK-BP, for a 20% stake in Rosneft, the state-owned Russian oil company, and $12.3 billion in cash.

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But not everyone is buying the takeover talk. “Although anything is possible, BP is too big to merge,” says Fadel Gheit, an energy equity analyst at Oppenheimer.

Down in Houston, energy bankers and oil executives uniformly shuttered at the notion that BP is now, or could be soon, the subject of a takeover. Insiders at ExxonMobil, one of the companies that Bloomberg cited as a possible merger partner, told Fortune that there has been zero talk of doing any kind of deal with BP recently.

But is it such a crazy idea to imagine BP one day merging with one of its Big Oil brothers? Up until recently, it was widely accepted that being bigger was the key to being a better oil company. That view was taken to its logical extreme in the late 1990s when the “Supermajor” oil company was born. But the impetus for the mergers of the late 1990s was sheer desperation, as oil prices had collapsed to as low as $10 a barrel.

Today, oil prices, while soft in recent months at around $90 a barrel, are nowhere near the levels seen in the late 1990s. At current prices, oil companies can comfortably make a fat profit drilling pretty much anywhere on earth.

As for reserves, from 2005 to 2011, the average reserve life (the years required to deplete a company’s proven oil and gas reserves at current production rates) of the majors have remained relatively stable at 12 years, with net additions from new discoveries replacing current production, according to energy analysts at Barclays Capital. Some companies have depended on acquisitions to extend their reserve life, namely Total, but the big guys like ExxonMobil and Shell have been more successful in growing organically. That’s not to say ExxonMobil (XOM) doesn’t do deals — it acquired natural gas producer XTO for $40 billion a couple years back — but it doesn’t depend on, nor does it actively seek out acquisitions to pump up its reserve life by a significant amount.

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To be sure, BP (BP) does have a lot of valuable assets that the majors would love to get their hands on. ExxonMobil still covets BP’s Gulf of Mexico assets, for example, even after the Deepwater Horizon disaster turned the Gulf into one big oil slick for a few months. The issue comes when you start talking about absorbing all of BP, which still has operations up and down the oil value chain from the bottom tip of Africa to the top of the Artic. Combining all of those operations just seems like a headache that isn’t worth the trouble, especially when companies can still replace their reserves profitably.

Oil companies, especially ExxonMobil, are extremely conservative and aren’t prone to jump into a deal unless they know they can make serious money. In the case of ExxonMobil, that is somewhere around a 35% return on average capital employed – making private equity look like underachievers.  That would mean that BP would need to be acquired at a major discount, something that BP management isn’t prepared to do. While it is true that BP is trading at a major discount to it peers, with a price-to-earnings multiple of 7.1x versus 11.1x for ExxonMobil, it has always been a laggard for one reason or another.

And while BP has successfully negotiated settlements with the government and private individuals in connection with the Gulf oil spill, it isn’t out of the woods just yet. BP still needs to settle “grossly negligent” charges brought under the Clean Water Act and the Oil Pollution Act. That could cost the company as little as $5 billion to as much as $30 billion or more. A trial is set for February, so the hope is that BP settles before then so it can truly move on.

So even if it makes economic sense to merge, don’t expect a big oil deal to spoil your holidays. With a $130 billion market cap, and billions of dollars in unknown liabilities, BP remains one big toxic mess, which no oil company would want to acquire.