The Guide to Investing in Stocks and Shares

BP - Follow up

Dan Tebbutt - A Shareworld Contributor

Published - 29th July 2010

Back in June I wrote an article on BP expressing my belief that it was "worth a punt" at 400p. I subsequently put my money where my mouth is and put about 10% of my personal portfolio in BP shares at an average price of 354p (you can follow my trades as I make them on my blog). 6 weeks later the share price is at 400p again, but events have certainly moved on. Is 400p a reasonable price, or is BP still a bargain?

Key events

On the 17th June, after a meeting with President Obama, BP agreed to set up a $20bn escrow fund to cover compensation payments and state and local cleanup costs. Their own cleanup costs and any fines and penalties will be paid separately.

On the 12th July BP installed a “3-ram capping stack” onto the Macondo well and on the 15th July the stack was closed, shutting off the flow of oil into the Gulf. It has remained closed ever since.

BP's two relief wells remain on track, and the first is expected to intercept the well and kill it at some point during August.

Reported costs

BP released their results for the second quarter on the 27th July. This lays out their own estimates of their liabilities for the spill (although see Contingent Liabilities below for some crucial exceptions) and should be a good starting point.

BP have reported a loss of $17bn after tax for the second quarter. Note 2 to the accounts covers the impact from the Gulf of Mexico, but to summarize:

• A total of $32bn pre-tax costs have been recognized, comprising:
  • Cleanup costs and compensation claims paid to date.
  • The $20bn escrow fund.
  • Provisions for future cleanup costs.
  • Estimated fines payable under the Clean Water Act.
• A tax credit of almost $9.5bn has been recognized, since the cleanup costs and compensation claims are all tax-deductible (fines and penalties are not).

Contingent Liabilities

There are a number of costs that BP may face in addition to those recognized in its second quarter results, and also a few potential sources of revenue.

Firstly the $20bn escrow fund does not put a cap on BP's civil liabilities. On the other hand, nor does it put a floor on it - if all legitimate claims are paid and there is money left in the kitty, that will revert to BP.

BP's assumptions as to the level of fines and penalties they will pay are based on them not being "grossly negligent". If they are found grossly negligent then their fines under the Clean Water Act could quadruple, meaning in excess of $10bn of extra fines (which are paid post-tax).

On the other hand, 35% of the costs associated with the spill should be paid by the well's co-owners: Anadarko and Mitsui - provided BP are not grossly negligent. Because recovery of these sums are uncertain, BP has not recognized this in their accounts, but this could be a significant plus if the courts find in BP's favour.

BP could face further costs from a variety of sources - punitive damages from court cases, fines or penalties from a variety of investigations, etc.. These are all essentially unknowable at this stage, and therefore BP have not allowed for them in their accounts.

Upside

BP's second quarter loss amounted to 60p per share. If they are found If that is the total of the costs they face, then a fair price might be 525p (650p pre-crisis price, minus 10% to track the movement in the Shell share price, minus the 60p loss). In an ideal world they might even recover billions from the well's co-owners, and get reimbursed an unused part of the escrow fund, but let‘s not go crazy.

Downside

If BP are found grossly negligent then a wild guess at their additional costs would be:

• $15bn of additional fines (assuming additional fines of $3k per barrel of oil, and being pessimistic about the total leakage so far).
• $10bn of additional civil damages
• $10bn of punitive damages

The fines will not be tax deductible. The civil damages will be. The punitive damages are at the moment, but might not be by the time BP incur them - the "American Jobs and Closing Tax Loopholes Act of 2010" is proposing to reverse the current position. This is my downside scenario, so lets assume only the civil damages can be offset against tax. That takes the post-tax total to $32bn, or 110p per share.

Subtracting that from my upside price of 525p takes us down to 415p - a price BP have hit a few times in recent weeks.

Conclusion

BP shares are still pricing in my worst-case scenario. I'm going to hold on for a better price - somewhere between my two scenarios would be reasonable: say 450-480p.