BP Quietly Hits A Grim Milestone

Lost amid the languid slide into the Labor Day weekend and the general Wall Street obsession with the next new thing, BP (NYSE:BP) quietly reached an unfortunate milestone last week. The large international energy giant announced that the company had spent $8 billion in direct costs tied to the Deepwater Horizon/Macondo disaster. These costs include the direct costs of addressing the spill, as well as various claims paid to date, but likely do not come close to the ultimate cost. 

Better, But Not Over
It does appear that the worst is over for BP in terms of the actual well disaster. Oil is no longer leaking from the well (at least not in significant measurable quantities), the company has successfully cemented the well and Transocean's (NYSE:RIG) Development Driller II and III are on the job for the drilling of the relief well. In a relatively short time, then, the technical and engineering aspects of recovering from the disaster could be at a close.

That is not to say that this accident will not continue to haunt BP and the Gulf coast for years to come. The environmental impact is still very much unknown, though rather likely to be less severe than the radical predictions that it would devastate the area and its economy for decades. All the same, it seems like a virtual certainty that BP will continue to face new claims and will have to go to court with those claimants who refuse BP's settlement offers. (For related reading, check out The Great Oil Spill Of 2010.)

To read the full piece, please continue on to:
http://stocks.investopedia.com/stock-analysis/2010/BP-Quietly-Hits-A-Grim-Milestone-BP-RIG-APA-ME-HERO-NBL0908.aspx

Big OIl Looks To Prevent Another Oil Catastrophe

Give the energy industry titans a little credit - they learn slowly, but they do learn. Late Wednesday, four major international energy companies announced a joint venture aimed at developing and preparing equipment to handle future oil spills in the Gulf of Mexico (and perhaps in other offshore locations as well).

As it stands now, the agreement includes Exxon Mobil (NYSE:XOM), Royal Dutch Shell (NYSE:RDS), Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP). Each company will contribute $250 million to the venture, which will be called Marine Well Containment Company and established as a non-profit entity.

For the full column:
http://stocks.investopedia.com/stock-analysis/2010/Big-Oil-Looks-To-Prevent-Another-Oil-Catastophe-XOM-COP-CVX-RDS-APA-CAM-NOV0726.aspx

Of course ... by taking this step, these companies guarantee that the next major disaster will be something completely different and will leave them flat-footed. 

I'm Such An Idiot

Sometimes I feel like I have to look in the mirror, take a deep breath, and confess to myself that I'm an idiot.

For all the time I've spent talking about BP (NYSE: BP) and Transocean (NYSE: RIG) and all that, I don't know how I could have missed one of the slam-dunk plays on this mess.

Clean Harbors (NYSE: CLH).

One of their main business units is spill clean-up. Hell, it's basically in their name!. Now, I don't know how much (if any) business they're getting from the mess in the Gulf ... and I'm too ticked at myself to go look it up right away. What I do know is that the stock has done quite well ever since it was clear that this would be a serious spill.

What is interesting, as a side note, is that Veolia (NYSE: VE), a French services company which also does industrial/environmental clean-up has gone the opposite direction since the spill. Go figure.

Anyways ... maybe there's still money to be made in Clean Harbors. But I know this missed opportunity is going to bug me for a few days...

BP, Anadarko, and Transocean - Splitting the Bill

I thought it might be interesting to get a better sense of what the total bill for the oil spill might be and how that stacks up to the liquidity of the companies on the hook. Clearly there are a lot of guesses and assumptions here, but I felt it was worth taking a stab at it.

The Clean-Up
I looked at the Oil Spill Intelligence Report to get a sense of what past spills have cost. There is a wide range of factors that go into the cost, including the type of oil ("lighter" is better), the size of the spill (bigger gives economies of scale), how much coastline is involved, and so on. All in all, the costs seem to range from $5,000/ton to $34,000/ton. 

Obviously it's hard to get a firm estimate of how much oil is in the Gulf, as BP's guesstimates have been woefully inadequate. So far, I'd estimate that anywhere from 100K tons to 135K tons has been spilled, and that we're now at about a 4K ton/month rate. So if this spill is plugged by the end of August, we might be looking at something like 125K tons.

I'm going to assume a cost of $20K/ton and a total 140K tons. That's a total clean-up bill of close to $3B. Extending the math, figure on $80M/month if this stretches past August, but at a reduced rate of flow.

Punitive and Compensatory 
History suggests a 1:1 ratio of punitive to compensatory damages, but that ratio may be optimistic and conservative given the tenor of the Obama administration and the changes in the class action legal environment since the time of Exxon-Valdez (the best and closest analogue).

So, how to estimate compensatory damages? I've seen estimates that range from $3B/yr to $9B/yr in terms of the annual economic activity that is imperiled by the spill (and obviously this goes up as the spill lingers on and affects a larger and larger area), but the tourism cost could be even higher. It's also reasonable to assume that the area of effect will linger for a few years, but at a declining rate each year.

I'm going to go with a total educated guess of $10B - $15B in total compensatory costs, so the total of punitive and compensatory could be $20B - $30B.

Fines
Violations of the Clean Water Act, Migratory Bird Act, and so on could easily kick another $500M - $2B into the kitty. 

The Total
That leads me to an estimate of $23B - $32B in total damages, with full admission that punitive costs could be higher (but probably no higher than 3x the compensatory). Maybe the absolute worst-case, then, is something like $65B?

Who Pays?
Clearly, the wrangling has just begun on this topic. BP (NYSE :BP) has already begun paying claims and has consistently acknowledged their responsibilities to pay. One big question is whether Anadarko (NYSE: APC) gets drawn into this, and how deeply. Anadarko has a 25% interest in the well. In a best case scenario, Anadarko escapes by hiding within the Oil Spill Liability Trust Fund that limits liability to $75M. Worst case is that they're drawn in to a proportionate share of the total cost.

Cameron (NYSE: CAM), the maker of the blowout preventer that failed, is not likely to be on the hook here, in my view. The BOP was nine years old and information has come out that Transocean (NYSE: RIG) modified the BOP at BP's direction. That, in my mind, basically gets them off the hook.

Likewise, Halliburton (NYSE: HAL) has the advantage of a contract that limits their liability. As I've said before, I still think there's a chance that HAL gets tagged for a bad cementing job and drawn into this, but that's a big unknown right now.

Last and least, Transocean likewise has a contract that limits its liability, and there has been a fair bit of information coming out that Transocean was just following BP's orders all along the way. Does that hold up? I think so.

The Market's Moves So Far
So what is the market discounting for this mess? Let's look at the amount of market cap lost since before the spill.

BP - $86.5B
APC - $17B
RIG - $16.7B
HAL - $8.3B
CAM - $2.4B
SII - $2B

So, the market has taken out about $133B in market cap ... 2x what I think is a reasonable worst-case scenario.

Can The Companies Afford It?
But can they pay?

BP has $7B in cash and should be able to produce another $6B - $9B in free cash flow per year (and this WILL go on for years...). BP is also relatively underlevered and could probably borrow at least another $10B free and clear. On top of that, BP has over 10B in oil reserves, and those could either be sold or used as collateral if need be. The going rate for oil deals has been around $20 - $25/bbl, so that gives a decent idea of the resources BP can bring to bear.

So, if BP has to go it alone, it'll be a tight squeeze, but BP won't go away. They may have to meaningfully cut the dividend in the meantime, though, particularly if Anadarko does not have to chip in.

As for Anadarko, they have more than $3B in cash on the balance sheet, manageable debt, and can generate about $1B-$2B/yr in free cash flow. So, if Anadarko has to pay up to their economic interest (25%), they could be looking at a bill between $5B and $8B. This would be more of a strain on Anadarko ... enough, perhaps, that an unfavorable ruling that pushes them to pay their 25% might lead them into an M&A transaction with a bigger firm that has the cash to pay up. Of course, Anadarko also has oil reserves that could be monetized.

For HAL and RIG, there is about $3B and $1.5B in cash, respectively. I don't see either getting drawn into this, though, so that should be fine. That said, HAL, RIG, and CAM are all going to suffer from the decline in Gulf of Mexico and deepwater business, so I do not read their declines in market cap as being due to potential liability, but to a decline in business and maybe a dented reputation.

Okay, admittedly this was a long piece, but maybe it will be interesting to a few readers. Looking at this all by the numbers, I end up feeling better about BP, worse about Anadarko, and really no different about Halliburton or Transocean. It would take a total bill of over $60B to bankrupt BP, though admittedly the company will be hurt significantly at lower levels. As for Anadarko, they are going to be hurt by the moratorium and there are definitely some risks to the company with the combination of a high bill bill and 25% participation.

All in all, I still think you can buy BP, RIG, and CAM here. APC is a bit more questionable, and I might be more careful there.

Is The Government Pushing Its Luck With BP?

Another day, another volley from the federal government lobbed at BP (NYSE: BP). This time, though, the survival of the company may now actually be in question.

Today's news has the Interior Secretary "encouraging" BP to pay the salaries of oil workers laid off because of the government's decision to impose a six-month moratorium on offshore drilling and completion activities. I have no idea how much money this will ultimately be, nor how many people the government will try to shove under BP's umbrella, but it feels safe to assume that it will be quite a bit of money.

Am I the only one here who thinks this smacks of what you hear about in the third world, where governments charge the families of political prisoners for the costs of their incarcerations and/or executions?

In any case, this comes on top of the already $1.3B+ in likely economic damages that BP will have to pay, to say nothing of billions more that the U.S. government is going to attempt to levy in civil and criminal penalties. On top of *that*, figure on even more lawsuits (class action and otherwise) to come from people who incurred real damages from this spill and those who simply see a chance to chase a fat, juicy ambulance.

Right now speculation is starting to swirl about whether or not BP will have to seek bankruptcy protection. As of the end of 2009, BP had about $101B in positive book value, about $37 billion in debt, and about $8 billion in cold hard cash.

I think bankruptcy is probably a stretch at this point. That $8 billion in cash does not include any ongoing positive free cash flow (which could easily be $7 billion or more per year), so unless the government drastically overplays its hand, I just don't see the company coming to such dire financial straits that bankruptcy is financially necessary. Remember, it will take up to a decade for all of this to get resolved and BP won't be writing big checks for some time to come.

What could happen, though, is a strategic bankruptcy for the U.S. subsidiary of BP. I truly have no idea how that would impact the legal wranglings that are going to involve BP for a decade to come. I would suspect that a bankruptcy of the U.S. subsidiary would be a large middle finger extended towards Washington, D.C. and would complicate efforts to get payments from BP above and beyond any assets residing in the U.S. subsidiary. On top of all that, I have to wonder if this is going to become a diplomatic issue at some point; I cannot imagine that the U.S. government would let a foreign government push ExxonMobil (NYSE: XOM) or Chevron (NYSE: CVX) to the point of bankruptcy, so I have to think that the British government gets involved before too long.

Along similar lines, the ongoing trouble for BP looks increasing bad for Anadarko (NYSE: APC) (BP's partner), Halliburton (NYSE: HAL), and Transocean (NYSE: RIG). The worse this situation gets, the more incentive BP has to spread the economic damage. Though I still think Transocean (and Cameron (NYSE: CAM) walk away from this in good shape, Halliburton and Anadarko could have something to worry about.

On top of that, the knock-on effects to offshore players like Apache (NYSE: APA), Cal-Dive (NYSE: DVR) shouldn't be ignored, as the cost of doing business off the coast of U.S. (and maybe even the opportunity to do so at all) is definitely now in question.

Here's hoping that U.S. government sees reason and doesn't push their luck too far with BP. Like it or not, the U.S. oil industry is a significant part of our energy infrastructure, and the oil industry is a major source of jobs and state tax revenue in places like Texas and Louisiana. Seek justice by all means, but when it teeters over into populist vengeance and confiscatory retribution, the government may just find that it has made us all poorer in the long run.

Bottom line - I'd still be interested in stocks like Apache, Transocean, and Cameron. I still think BP survives this and works long-term as a stock, but you really have to have a strong stomach to step up today.

Deepwater Horizon Disaster Just Keeps Getting Worse

I hope it doesn't sound too glib to categorize the latest developments in the Deepwater Horizon disaster as "... and the hits just keep on coming". What was already a bad situation for BP (NYSE: BP), Anadarko (NYSE: APC), Transocean (NYSE: RIG), and Halliburton (NYSE: HAL) just seems to be getting worse and worse.

As of Tuesday evening, it seems pretty clear that BP's efforts to stop the well from pouring even more oil into the well have failed. Making matters worse, the options left to BP are increasingly bad and the odds of success are increasingly long - a kill well has to be positioned with an extreme amount of precision and it will take quite a while to execute the procedure in the best of circumstances.

Making matters still worse (but probably not surprising those who have been watching this unfold), the U.S. government announced a criminal probe after the close. There's a pretty healthy list of laws and statutes that the government can site, including the Clean Water Act and an act designed to protect migratory birds. Now, the likelihood of anybody going to jail is vanishingly small, but the process does open up the possibility of even more financial punishment to the companies involved.

On top of that, a criminal probe gives the government more leverage in punishing the companies involved. In the process of a settlement, the government can reach for terms that otherwise would not likely be on the table in a simple criminal proceedings. As part of this, then, BP could face sanctions and restrictions on its ability to drill in U.S. waters.

It seems like the government is focusing on BP, Transocean, and Halliburton (those are the three companies that the government has told to keep records), but I would not give a free pass to Cameron (NYSE: CAM) or Smith Intl (NYSE: SII) just yet. After all, if and when it turns into a witch-hunt, anything that looks like a witch is going to get caught up in the mess.

I still believe in the long-term validity of the companies caught up in this man-made disaster. If you have a long enough time horizon, this is probably a very good time to buy shares in BP, Halliburton, Transocean, and Cameron. But there's no way of telling whether there's 20% more downside (or even more) as this all rolls out.

It's interesting (to me) to recall that Exxon (NYSE: XOM) shares really didn't fall that much in the wake of Exxon Valdez. In fact, if you look at a chart including a few years before and after the spill, you can't pinpoint the spill just from the stock chart. In contrast, the stocks of the companies involved in Deepwater Horizon have gotten pounded.

Long-term, there's not much that the government can (or will) do that would permanently impair the ability of these companies to prosper from ongoing appreciation in energy prices. If you can stomach the risk of seeing another 10-20% (or more) downside risk from here, these could be good buys today. But given how long this mess is going to drag out, you probably have plenty of time to accumulate the stocks.