The Gulf of Mexico oil spill has put British oil giant BP Plc (BP) squarely at the top of the corporate pariah list. This environmental catastrophe has not only made BP everybody’s chief villain, but also put an unflattering public spotlight on the oil industry’s Achilles heel: deepwater drilling.
While the damage to the environment and Gulf Coast businesses is very real, this crisis and its effects are also expected to create its own set of winners and losers. On top of the losers list is BP, which has not only lost more than a third of its market value, but is also facing doubts about its ability to exist as an independent entity.
Real and speculative stories about BP going the rounds in recent days range from the risk of government expropriation of the company to its emergence as a buyout target to talk of a dividend cut. My goal in this write-up is to size up these stories to answer the ultimate question of whether the company can survive in its present shape.
Government Expropriation
Let me take on the easiest-to-tackle issue (basically a rumor) first — that the U.S. government will expropriate all or part of BP’s assets. This is a non-existent threat and doesn’t hold any water. The U.S. is a country of laws, with a proud tradition of property rights. While BP is no doubt exposed to a host of liabilities and lawsuits, including the Justice Department’s civil and/or criminal probes, they will be all be determined under the due process of law. BP may be a pariah, but there should be no doubt that it will get fair and transparent judicial treatment.
Is BP a Buyout Target?
After losing about a third of its market value, BP’s market capitalization has slipped from being the second among the five super majors — Exxon (XOM), BP, Chevron (CVX), Shell (RDS.A) and Total (TOT) — to around the same level as France’s Total. The company’s diminished value has prompted rumors that it could be in play, withExxon and Shell often cited as the potential acquirers.
While BP’s lucrative portfolio of oil and natural gas assets would make it an attractive target, I don’t consider it a viable option for three reasons. First, no super-major would like to shoulder the unquantifiable liability exposure of BP. Second, anti-trust concerns in the U.S. and Europe would make such a combination a hard sell. And third, BP has a significant downstream (refining & marketing) presence, which isn’t of interest to any of the super-majors.
How Secure is the Dividend?
This may actually be the more plausible of all the concerns about BP, given the company’s deep set of current problems. However, there are two aspects to the dividend decision — financial and perceptional (or political).
Let’s address the financial aspect first. Looking purely at the company’s financial profile, I wouldn’t consider the dividend to be at risk. Behind this view is a conservative look at the company’s cash flows this year and next versus its need for capital expenditures, dividend payouts and other spill-related liabilities.
BP plans to spend around $22 billion on capital expenditures this year and around that same level next year, while its annual dividend payouts amount to around $10.5 billion. In terms of operating cash flows, the company will generate anywhere from $25 billion to $34 billion this year, depending on oil prices ranging from $60 per barrel to $80 per barrel (keeping natural gas constant at $5 per Mcf). As long as oil and natural gas prices remain in this range or above, the company will have sufficient internal cash flows to meet these needs.
In addition to its ample operating cash flow cover, BP also has a fairly strong balance sheet, notwithstanding its recent rating downgrades that still leave it in pristine investment-grade territory. It had a net debt-to-capitalization ratio of around 19% as of the end of the first quarter. This leaves BP plenty of capacity to raise debt to meet its obligations. BP also has an ongoing asset disposition program that can be expanded to raise more cash.
The point is that from a purely financial standpoint, the company has sufficient resources to meet its needs without needing to cut the dividend.
The Politics of the Dividend
But continuing to pay the dividend may not be a purely financial decision from the management’s perspective. This message came across clearly in the conference call that management held for investors on Friday. Management highlighted on the call the importance of the dividend to shareholders, but failed to give categorical assurance of its safety.
Political rhetoric on the dividend issue has been heating up in recent days. A number of senators have stated that they would like BP to suspend its dividend while the full picture of its spill-related cost liability remains unclear. And even the President commented on it last week stating that ‘I don’t want to hear BP is nickel and diming’ the Gulf Coast residents while it continues to spend money on image advertizing and dividends.
The bottom-line is that while financially the company may be able to support its dividend, the political backdrop may make it untenable.
Sizing Up the Liability Related to the Oil Spill
All of this analysis comes down to the eventual size of the company’s total liability exposure resulting from the spill. And that is not easy to quantify — at least not at this stage.
A point of reference could be the 1989 Exxon Valdez spill, which eventually cost ExxonMobil $4.5 billion, including clean-up costs, legal settlements and punitive damages. But BP is sitting on a much bigger disaster, and as a result will be footing a much bigger bill.
BP has already spent around $1.3 billion in cumulative spill-related costs, which works out to a roughly $28 million daily cost since the explosion about 45 days ago. For making a ‘guesstimate,’ I rely on the assumption that this estimated daily spend run rate continues, at least through the end of the completion of the relief well into late August. That works out to additional gross outlays of about $2.4 billion, bringing the total at that stage to about $3.7 billion.
But clean up will most likely continue for awhile beyond that stage. An admittedly arbitrary doubling of the guesstimate — to account for clean-up costs beyond August — would take the gross tally to $7.4 billion. As noted earlier, this is a very rough estimate, and the actual number will almost certainly be completely different.
Then there is the very real issue of litigation, both from Gulf Coast residents and businesses and as well as the Federal and State governments. While some estimation could be made of expected penalties under the Clean Water Act, for example, it is extremely difficult to have a full appreciation of the company’s liability exposure from future litigation.
But while the extent of that exposure is uncertain at this stage, it is fair to assume that it will be years before BP has to make payments. For reference, keep in mind that Exxon completed its final liability payment related to the 1989 spill only recently.
We should keep in mind that BP owns 65% of the oil well in question, with the rest of the 35% held by Anadarko (APC) and Japan’s Mitsui. While BP obviously will have the lion’s share of the liability exposure, it will not be 100% of the total, either.
Can BP Survive the Spill?
There is no doubt that BP’s image and reputation has been battered by this event. And the financial liabilities will no doubt be big. But we doubt that even a huge liability bill — of, say, $25 billion to $30 billion — spread over multiple years can cripple this very resource-rich company. BP carries an investment-grade credit profile, owns billions of barrels in precious oil reserves, and generates a lot of cash.
So, while the stock may be risky and inappropriate for a lot of investors, the company’s existence is not in doubt, in my view.
Read the full analyst report on “BP”
Read the full analyst report on “XOM”
Read the full analyst report on “RDS.A”
Read the full analyst report on “CVX”
Read the full analyst report on “TOT”
Read the full analyst report on “APC”
Zacks Investment Research
