I have been digging through various sources trying to decide whether BP shares are a buy or a sell. Im still undecided at the present time but perhaps some of the things I have dug up might be of interest to others(for a fuller version of this note, see Buy or sell BP shares?).
Interestingly, BP plc sliced its dividend in half in 1992 after an ambitious investment program and protracted recession piled a crushing debt load onto its balance sheet. The shares sold off, but then rose sixfold over the ensuing years.
However, the oil giant faces this time a monumental technical challenge: getting the crude oil to stop flowing from the ruptured Deepwater Horizon well a mile beneath the surface of the Gulf of Mexico. There are some big unknowns here: how long it will take and just how much oilis gushing out each day?
These variables make it difficult to put a number on the ultimate financial liability. The truth is, no-one really knows the scale of the potential liability, notes the Financial Times Alphaville blog.
Estimates of the rate of leakage keep going up, and now stand at 35,000 to 60,000 barrels per day. Matt Simmons, the veteran oil analyst (responsible for the peak-oil theory) says that the speed of the flow likely entails the leak is 120,000 barrels a day. He also seems to think that drilling a relief well will not work, as the busted well likely doesnt have a casing and is effectively an open hole.
The Deepwater Horizon spillage is already at least eight times the size of the Exxon Valdez mishap. The bill for Exxon Valdez came to $7 billion (in current U.S. dollars), according to EnergyandCapital.com editor Adam Sharp, so by simple extrapolation, BPs bill could already be close to $50 billion.
My calculations may betoo simplistic. For one thing, as Chad Brandof Peridot Capitalist points out, BP only owns 65% of the broken well and the last Exxon Valdez spill claims were settled about 20 years after the accident occurred. So the current ballpark liability could be nearer to $35 billion and amortized over 10 to 20 years.
The problem, though, is that the well continues to spew crude oil– with no end in sight. What if the oil flow is not stemmed for another 50 days and the leakage rate turns out to be near, or above, 100,000 barrels per day? The total emission (since the well exploded) would amount to about 10 million barrels, which extrapolatesto a cost of about $250 billion. BPs share would be over $150 billion.
But even if the liability was too much for BP, the company could ring fence its problems, says Stanford Wealth Management CEO Joseph Shaefer. It could declare BP America insolvent and keep the remaining 75% of BP alive.
Then again, a Citigroup report concludes it would be very difficult, if not impossible, to put up a firewall. The credit rating on [the] subsidiary appears to be tied to the parent, which suggests the parent is a guarantor for BP America. Also, the U.S. subsidiaries also appear to be the domicile for many of BPs international assets.
Im waiting for more clarity before buying or selling BP shares, even though it may mean foregoing another 10% to 25% in returns. Another approach would be to buy BP shares and hedge with put options and/or covered-call options (but I wonder if BPs options might be fully priced by now). Or we might follow Pimcos Bill Gross and buy BP debt — the 12-month notes are yielding close to10% and could add anice capital gain to that income payment.
Adherents of the socially responsible investing (SRI) school might rule out owning BP securities on any count. The oil giant has given the world an environmental nightmare and owning its securities may be too repugnant a consideration.