Gulf Oil Spill: Fears of a BP Bankruptcy Filing Are Overblown
Financial markets are treating BP securities as if a bankruptcy filing was imminent. Depressed valuations represent growing fears of unilateral and putative action by a saber-rattling Congress and White House -- and not any real change in the U.K.-based oil major's ability to redress oil-spill claims. Still, fears that BP might file for bankruptcy protection appears to be unfounded so far.
Credit default premiums rose and stock prices fell again on June 14 as the Obama administration pushes forward with its demands that BP suspend dividend payments. BP also upped the current total cost of cleanup and containment for the Gulf of Mexico oil spill to approximately $1.6 billion.
BP shares have lost approximately $90 billion in value, or 51 percent, since the Deepwater Horizon accident touched off the Macondo field blowout in late April. The common stock settled at $30.67 a share in trading Monday, near a 14-year low of $29 a share, which it touched last Wednesday.
The cost to bond traders for five-year insurance protection against nonpayment (per contract covers $10 million in face value), better known as credit default swaps (CDSes), settled at $437,880 (CDS' trade in basis points) on Monday, according to CMA DataVision. On April 22, the day the Transocean (RIG)-leased semi-submersible drilling rig sank, the cost to insure BP debt was $43,200 a year on $10 million of debt, according to the credit information specialist.
Although BP debt holds investment grade ratings from major credit agencies (AA2, Moody's Investors Services and AA+, Standard & Poor's) -- just one notch below U.S. government debt) -- derivative traders view swap spreads of approximately 500 basis points as equivalent to junk. Insurance on BP's one-year swaps is more expensive than for its five-year debt, another sign of the company's alleged "short-term credit distress" risk.
On June 2, Credit Suisse estimated BP would end up paying about $37 billion in total costs for the spill, including $15.6 billion in clean-up costs and $14.4 billion of liability claims. This would absorb three years of BP's free cash flow after dividend payments and annual capital expenses of $21.5 billion (at an average price of $80 oil), according to in-house analysts.
New modeling estimates, however, put the oil spill rate at a range of 30,000 barrels to 40,000 barrels per day, almost twice the investment bank's top in-house assumption of 19,000 barrels a day. Consequently, aggregate costs will be revised upward, near $50 billion.
Credit Suisse believes contractual obligations totaling $184 billion (2010-2014) can be honored with operating cash flows. It's worth noting, however, that bond traders could be shorting BP securities on speculation the oil giant will have trouble meeting near-term needs, as payment for more than 55 percent of these obligations, or about $108 billion, comes due this year, including: $9.7 in maturing debt, $3.2 billion in operating leases, and $92.5 billion in purchase obligations (mostly for refinery operations, such as oil and gas feedstock).
Unless BP makes a mad rush to draw down existing net borrowing facilities of $15 billion -- or commercial paper markets shut out the company -- trader fears of liquidity problems are likely exaggerated.
BP's forward gearing (net debt to equity) through 2013 isn't anticipated to rise above 25 percent, which leaves the company with ample wiggle room to meet higher clean-up costs. At March 31, the net debt ($25.2 billion) to equity was 19 percent, according to BP's first-quarter 2010 regulatory filing. Unless the company is willing to either cut its exploration budget or sell more debt, the fiscally prudent -- and politically correct -- course of action is the much talked about dividend cut: a dividend suspension leads to a three-year pre-tax savings of $31.5 billion -- more than enough to cover containment costs from increased oil flow rates.
The biggest risk to cash flow through 2013, in my opinion, is increasing regulatory oversight and resultant slowdown in North American drilling activities. BP derives about 25 percent of total hydrocarbon production, or 1 million barrels of oil equivalent (oil & natural gas) per day from U.S. holdings; the company is the biggest producer in the Gulf of Mexico, with daily production from about 20 active fields totaling more than 4 million barrels per day of oil equivalent.
In addition, BP is the largest leaseholder in the deepwater Gulf, with more than 650 lease blocks in waters deeper than 1,250 feet. The current moratorium on deepwater drilling (which affects four BP leases), combined with more complex regulatory oversight calls into question the development of lucrative ultra-deepwater fields -- located in Gulf waters as deep as, or deeper than the sited Macondo spill. BP is a 70 percent operator of the Kaskida field, discovered about 250 miles southwest of New Orleans, at a drilling depth of 32,500 feet in water of almost 5,700 feet; and, the Tiber field, sitting in 4,100 feet of water, with exploratory drilling to a depth estimated at more than 35,000 feet, making it one of the deepest wells ever spudded.
At year-end 2009, proved reserves totaled 18.3 billion barrels of oil equivalent, of which 45 percent were located in the U.S. As mentioned, the imposition of more restrictive drilling obligations and tighter environmental (including health and safety) protection controls will delay development and recoverability of these assets (accepted accounting timeline for production is five years), leading to asset impairment charges and lower cash flow projections going forward.
Most observers expect the leak won't be capped until mid-August, at the earliest. U.S. Coast Guard Admiral Thad Allen, the federal government's incident commander for the spill, said on the June 11 daily briefing that the arrival of additional mobile drilling vessels and tankers could bring daily processing capacity up to 38,000 barrels toward the end of June. The risk to this scenario is traffic congestion: the dance of 15-20 vessels in a two-square mile radius and 16-20 remotely operating vehicles monitoring the ruptured wellhead 5,000 feet underwater.
The downward pricing biases on BP's securities do suggest that industry analysts have yet to fully discount the full impact of the oil spill on the company's U.S. exploration and production activities -- which in fairness, will remain uncertain until BP gains full control over the oil spill. Nonetheless, unless gross negligence by BP can be proven, a review of BP's cash flow and balance sheet profiles concludes the company's debt doesn't warrant speculative talk of insolvency.
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