Saturday, June 12, 2010

BP, Chance Of A Good Trade?

Chance of a lifetime? In a crisis, sentiment will crowd out sensibilities. Has BP fallen enough? Many analysts are trying to calculate the damages from the oil spill. My verdict is investors should carve out their intended exposure into 3 parts, and start buying one third now around $33-$35. Only buy the second parcel if it hits $29 or $37. The last parcel should only be bought when it tries to breach $40. If it continues to fall below $29, wait for $25. I could be writing a long essay on that strategy, but if you sit and think, you should come to why that strategy is sound.

BP has said that it will cover all legitimate claims resulting from the spill. But can it handle a worst case scenario? BP is already spending millions to control the spill, but reparations for economic damage could run into many billions of dollars.

On the income side, BP certainly has the resources to handle a sizable number of claims. The oil company had income last year of $63.4 billion. The total market value of the company currently sits at $142 billion.

Now let's look at the liability risk, starting with just one county. In Harrison county, MS, due north of the spill, the total economic activity at risk is in excess of $1.4 billion. In the just the six counties closest to the oil spill the potential economic activity imperiled by the spill comes to $4.9 billion.

But there are more than 50 counties potentially in harm's way, from the Florida Keys to the coast of Texas - and that's not counting the exposure BP would incur if the oil flows around the Keys and up the East Coast by way of Gulf stream currents. With tar balls showing up now on the Florida keys, that's a possibility that can't be discounted.

Wall Street analysts continue to believe that BP can pay for its mess in the Gulf, although their confidence level has been dinged by the company's inability to stem the spill - and the political fallout. But at $32.20, the shares are still trading at levels last seen 14 years ago.

Spurred by pressure in the U.S. to fully compensate economic victims of the Gulf spill - and by Wednesday's nearly 16 percent stock plunge - BP officials early Thursday reiterated that the company has enough cash to cover the costs of the Gulf spill.

Analysts agree, saying that BP will have around $5 billion this year to pay damages and clean-up costs once dividends and capital expenditures are covered. BP has already spent more than $1.4 billion trying to contain and clean up the oil and pay claims to Gulf coast businesses.

To date, almost 42,000 claims related to the spill have been submitted and more than 20,000 payments already have been made, totaling over $53 million.

Because of BP's strong cash flow, analysts currently doubt that the costs of cleaning up the mess will push the company into bankruptcy. A worst-case scenario for financial damages and penalties is more than $60 billion, which would be paid out over several years.

I suspect in terms of liability, a lot of it can be recovered from insurance and limited liability claims. What the company cannot recover from may be " company standing and reputation" going forward. Once the liability component has been ascertained, I strongly feel that the board will have no choice but to sell to probably Petrochina, the only one with the resources to claim that asset. A combined PetroChina-BP would have oil and gas reserves that were 73 percent and 187 percent larger, respectively, than ExxonMobil Corp and Royal Dutch Shell Plc.

The sale to Petrochina has to go through as BP tries to distance itself from the negative press and claims going forward. By selling, it will give BP a fighting chance to re-emerge from the disaster. A lot of pension funds, especially in UK will be putting a lot of pressure on the board to sell, and they will probably get the quickest deal at the best price with Petrochina.

Looking at the possibility of a $60 billion worst case scenario by Oppenheimer, the assets of BP is still more than doubled that easily. Its income per year would cover that. Stanchart see a worst case scenario costing BP $40 billion.


Casper said...

Some of the indirect claims the US goverments are asking is truly ridiculous anyway - if those things stands, then surely the US ibanks should be sued for all the worldwide output collapse for their roles in the financial pollution caused by the subprime mrotgages.

BP-Petrochina could be an interesting one definitely.

snowball said...

Hi Dali,

The PetroChina-BP merger does looked good on paper but what about the politics that surrounds the acquisition? The previous time a Chinese oil(CNOOC) company try to take over a US oil firm(Unocal), it is blocked by the Congres. Although BP is a British firm, they are the largest oil driller in the Gulf of Mexico(40% of BP assets are in US), it is unlikely that the US congress would allowed a Chinese company to own a huge chunk of their oil reserves.

Anyway, on the liability side, BP do not have any external coverage for this oil spill. All BP activities are insured by their own subsidiaries, Jupiter Insurance. So, the liability will rest on BP.

But, regardless of the insurance coverage, BP will earn its way out of this mess. The potential liability looked huge right now, but, the present value of it would be considerably smaller. Exxon just paid off its fine of Exxon Valdez spill last year-20 years after the spill. I think this case would be the same where BP would probably engage in a long legal process in court while earning enough reserves to pay the final legal bill in the future.


solomon said...

Fung Shui changed?

I still remember the EAst India Company and the Opium War in my history class....if ever the Petrochina and BP deal materialise, it is a total change of fortune now....

If US consumer boycott BP, the effect might be greater than the hedge fund bet of its downfall??

Anyway some time we might have to admit lah, if this happen in Malaysia, are we deeply concerned with the environment or investors? That is the primary difference I could observe between the West and us......what say u Dali?

vincent said...

On a totally different perspective:

This is BP's 3rd MAJOR disaster in 5 years after their Texas City refinery explosion and Alaska's Prudhoe Bay oil leak.

For an oil and gas company of that size and apparent technical know-how, that is unacceptable. Both earlier disasters pointed to poor maintenance as a result of excessive cost cutting measures. This current disaster could well be due to the same reason.

Once equipments are neglected for years and poor maintenance carried out, there is no turning back the clock; you can't fix the situation even if you threw money at it now. If that is the case, expect more major disasters from them in the very near future.

kl said...

I'm waiting for the next piece of hyped up bad news before I buy. Share price now reacts too much to political & headline news. If dividend is cut or shelved altogether, and Chairman resigns to take blame, that should be a signal. I am looking at US$25 to make 1st entry.

Dominic said...


Should I buy in London SE or NYSE?

Which is better tax wise and transaction wise.


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