Just barely over 3 short years ago, BP (BP) presided over the worst man-made disaster in history. It is estimated that over 210 million gallons of oil were dumped into the Gulf of Mexico, 19 times as much as was spilled in the Exxon (XOM) Valdez Oil Spill. Exxon is still alive and very well, currently in the number two spot among the Fortune 500 among biggest companies by revenues. BP, likewise, seems to have survived just fine and continues to rake in billions in net income, pays a healthy 5% dividend, currently trades with a market cap close to $140 billion, had $4 billion in positive cash flow last quarter, and BP announced it is buying nearly $1 billion worth of shares back. It would seem that BP is unstoppable, with over $80 billion in tangible assets on its balance sheet. But could the latest details to emerge from the oil spill settlement bring BP to its knees?
The worst is yet to come in terms of economic damage to BP
We've all heard about the money BP has forked over and is forking over (billions of dollars) to clean up the gulf and to compensate fishermen, beachfront hotels, and even a $4 billion criminal settlement. Five states have recently filed their own suits against BP for lost tax revenue: Louisiana, Mississippi, Alabama, Florida, and Texas. They are each also suing Halliburton (HAL) for its role in the disaster.
According to this recent article, BP has paid $573 million to individuals and businesses in Alabama alone. $3.5 billion was claimed to be paid out in total under the Deepwater Horizon Economic and Property Damages Settlement, though a closer look at this statistics website (maintained and updated daily by the settlement administrator) shows that much of the $3.5 billion includes unpaid offers, so that number for those claims could certainly go higher as claimants reject and counter with higher offers. A closer look at many of the offers on the appeals section of the website has BP trying to make offers often for 15 cents on the dollar (and often ultimately losing its appeal attempts) so that $3.5 billion figure just for claims currently on the table with offers should balloon much higher.
Further down in the same article, is this disturbing (for BP) statistic:
In total, 172,000 claims have been filed in five states
Again, looking at the statistics site as of June 9:
Take that $3.5 billion number (actually $3,491,668,747) and divide by the number of offers of 43,821. It comes out to nearly $80,000 per claim. Now look at item number 4 "Business Economic Loss." Divide that total of $1,924,168,117 by the number of offers of 7,856. It comes out to almost $245,000 average per claim.
This presents two huge potential problems for BP. Number one, with 128,179 filed claims still pending that are mostly business economic losses, with the average of $245,000 that comes out to $31 billion. Number two, and it's a much bigger potential problem, is that businesses still have just shy of 11 months to file a claim as the cut off final date isn't until April 22, 2014. According to the settlement administrator, the pace of filings has been picking up in the last 3 months and is expected to surge while the denial rate has only been 16%. The settlement is uncapped. BP set aside $7.8 billion, but clearly its estimate was far too low as this figure has already been surpassed when factoring in the previous settlement prior to the current active one.
BP has been fighting the settlement and losing so far. Its next appeal hearing is set for July 8. If it wins its appeal, BP can be saved. If not, in BP's own words it said it would be "irreparably harmed." If BP loses its appeal on July 8, it could then become a stock to short over the next year. What a great endorsement from BP for investors to short it in light of its own dire warnings! The phrase "irreparably harmed" could perhaps be an exaggeration by BP in an attempt to win legal advantage, but if true there's only one kind of irreparable harm that I can think of, and that's a serious reduction in BP's earnings power (at best) as it is forced to sell off money-producing assets to pay for the settlement. Caution is advised, however, when shorting a stock that relies on an upcoming legal decision of a court. As history has shown, almost anything is possible outcome-wise when it comes to the court system. If the case goes to the Supreme Court, you might as well flip a coin when placing your guess on the ultimate outcome.
How The Settlement Could Bring BP To Its Knees
Even if you take the above $31 billion prorated calculation at face value while ignoring many of the "claims offers" are low ball offers from BP in the appeal phase that often lose, the total number of claims could easily triple just based on the 10.5 months left until settlement expiration plus the current acceleration in claims filed. $31 billion times 3 = $93 billion. That's more money than BP's entire net tangible asset base. Seems a bit extreme? Consider the entire states of Mississippi, Louisiana, and Alabama are eligible along with half of Florida and parts of Texas. These regions added together have around a $1 trillion GDP, and the settlement calls for individual payments that get a multiplier factor, not just for one year of loss! The numbers are staggering and could very well bring BP to its knees. Don't take my word for what could happen to BP, click this article here where BP is in a panic over these claims, giving examples including "a $21 million payment made to a rice mill in Louisiana situated some 40 miles (64.4 kms) from the coast that earned more revenue than in spill year of 2010 than in 2007, 2008, or 2009" and countless others in the pipe and to be filed over the next 10.5 months. The article is filled with examples of the types of claims going through since this settlement has no cap and very few industry restrictions.
Perhaps if BP loses its appeal in July and is consequently brought to its knees, it will be poetic justice. BP wrote the sloppy settlement and failed to put a cap on it and is now struggling to correct its costly mistake. Only this time instead of trying to cap the oil well gushing out, it's trying to cap its cash balance from gushing out.