When I hear about legal and regulatory issues I usually think about banking or tobacco companies. However, legal issues and regulation are becoming a bigger part of the energy business.
This could be good or bad for society. Regardless, as investors we have to ask if companies seeing increasing legal pressure are sufficiently cheap given these headwinds. If they are not cheap enough, then investors should back away.
BP Ban Could Benefit Competitors
The U.S. Environmental Protection Agency imposed a temporary ban on British Petroleum (NYSE:BP) to participate on new U.S. government contracts after the oil giant pleaded guilty to criminal charges related to the Gulf of Mexico's Deepwater Horizon well blowout two years ago. The disaster killed eleven people and turned out to become the worst environmental disaster in U.S. history. BP claimed it made significant enhancements after the accident, including adapting stringent standards for deepwater drilling which exceeds regulatory requirements and instituting leadership changes.
In its plea bargain deal with the Justice Department, BP agreed to pay $4.5 billion to resolve securities claims and end all criminal charges related to the Gulf explosion. BP's lawyers did not anticipate any suspension from any U.S. agency. The suspension will put a mark on BP's record and may give an edge to its competitors for future federal contracts. Interior Department's Bureau of Ocean Energy Management Director Tommy Beaudreau said, "That suspension applies only to new contracts with the federal government."
Existing contracts with the Defense Logistics Agency, including 22 awarded in fiscal year ending September 2011, are not affected. Bloomberg data showed BP as the biggest petroleum supplier for the Defense Department, cornering about $1.35 billion in contracts in 2011 - a 33% increase from $1.02 billion in 2010.
With the ban in place, BP won't be able to bid on two planned auctions for Gulf drilling next year. Washington-based Project on Government Oversight general counsel Scott Amey said, "If I were a competitor, I would definitely play the suspension up." The Defense Department may also have to source more from its other suppliers: Valero Energy (NYSE:VLO), Kuwait National Petroleum, Royal Dutch Shell (NYSE:RDS.A), and Chevron (NYSE:CVX).
BP is talking with the EPA about lifting the suspension and expects resolution by the first quarter of 2013. Public Citizen's Energy Program Director Tyson Slocum thinks BP should be banned for five years, the probation's duration received in connection with the plea bargain. A similar suspension imposed by the Air Force on Boeing's three units in 2003 was lifted in 2005.
Chevron's legal issues are a lot less worrisome.
Courts and global companies spend a lot of time and effort determining the best jurisdiction of a case. Fourty-seven Ecuadoreans are asking an Ontario court to seize various Chevron assets in Canada to satisfy a 2011 ruling handed down by a court in Lago Agrio, a town in Ecuador. The judge hearing a case thinks the case should be tried in the United States. On the first day of hearings on November 30th, Ontario Superior Court Justice David Brown repeatedly said, "You should all be in New York."
The Ecuadorean court's ruling ordered Chevron to pay $19 billion in health and environmental damages due to pollution resulting from toxic wastewater, discharged saltwater, and other oil drilling by-products dumped by Texaco from 1964 until it left Ecuador in 1992. Chevron acquired Texaco in 2001.
The Ontario case follows the Ecuadoreans' earlier collection efforts that include attempts to seize Chevron's assets in Brazil and Argentina. Chevron's Canadian assets, which include offshore wells, oil-refining complex, oil-sands projects and liquid assets held in banks, are expected to reach $12 billion as estimated by the Ecuadoreans.
Chevron argues, (and David Brown seemed inclined to agree) that the Ontario court has no jurisdiction because its Canadian units are indirect subsidiaries governed by separate boards, independent from the parent company in the U.S. through several levels of ownership. Attorneys for the Ecuadoreans must convince the court that Chevron and its Canadian subsidiaries should be considered as one entity instead of separate companies. Barry Leon, a partner at Perley-Robertson, Hill & McDougall said, "The expression that gets used legally is 'lifting the corporate veil' and disregarding the separate personalities. The courts generally, in Canada and elsewhere, have been reluctant to do that." An adverse ruling would risk Chevron's oil-production and refining operations across Canada.
Chevron maintains that the ruling is an offshoot of bribery and fraud and thus refuses to pay the $19 billion judgment, or entertain settlement talks. Chevron Chairman and CEO John Watson said the Ecuadoreans' lawyers "have blackmailed judges, bribed judges, falsified evidence, falsified expert witnesses, ghostwritten expert opinions and ghostwritten court judgments." The Ecuadoreans' plaintiffs' spokesperson Karen Hilton dismisses Chevron's charges saying, "Now that the Ecuador courts have ruled against the company, it is manufacturing fraud charges in a desperate effort to escape justice."
Transparency International ranked Ecuador 120th out of 183 nations in its 2011 corruption-perception index. In New York, Chevron filed a racketeering lawsuit against the Ecuadoreans and their lawyers for leading a fraudulent litigation against the company.
Both BP and Chevron are cheap:
Royal Dutch Shell
BP is cheaper than most of the stocks on this list when considering price-to-earnings, price-to-sales, and price-to-book multiples. However, there are plenty of alternative stocks on this list that are similarly attractive and have not been banned by the U.S. government. For this reason, investors should consider other cheap names on this list like Hess (NYSE:HES) and Royal Dutch Shell instead.
The same could be said for Chevron. It's cheap, but not as cheap as other stocks. Though its legal problems are less severe than those of BP, there are cheaper energy stocks out there to consider.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.