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The woes of BP’s oil spill are still making headlines these days. After several unsuccessful attempts at capping the oil spill, British Petroleum (NYSE:BP) is still unable to stop the oil from flowing in the water. With liabilities expected to reach several billion dollars, investors have been selling off BP’s stock, which has caused it to decline almost 50% from its highs in April. The uncertainties regarding BP's future liabilities, have caused the Obama administration to push for a dividend cut, in order to ensure that the company would have the cash to pay its obligations.

Right now British Petroleum is generating profits in excess of $6 billion/quarter, paying out $2.6 billion in dividends and reinvests the rest in the business. The oil spill so far costs approximately $1.5 billion so far, but the overall liability could exceed tens of billions of dollars. The biggest risk is not that the environmental cleanup will be very expensive, but whether BP would be required to pay punitive damages for compensation to thousands of small business owners in the Gulf affected by the oil spill. BP had approximately $12.20 billion in cash and short-term investments at the end of Q1 2010, which should be sufficient liquidity provided that punitive damages are not imposed. Without the push from the US government, the oil spill would not have cost too much. However, given the pressure from the Obama administration, the total cost of the cleanup could definitely balloon and become excessive enough to even put the company in jeopardy.

Sometimes, despite the company’s ability to pay dividends, the strong hand of the US government could temporarily disallow its dividend payments. Back in 2009 this was the case for some of the strong banks such as State Street (NYSE:STT), US Bancorp (NYSE:USB) and Wells Fargo (NYSE:WFC). Because the government imposed on to them to take TARP funds and asked them to conserve cash, these financially sound institutions had to drastically reduce distributions.

While there are thousands of fishermen and business owners who would be negatively affected by the oil spill, there will be millions of retired investors worldwide whose lifestyle would be negatively affected by a potential dividend cut or suspension.

Times online reports that on Monday, BP’s board will hold a teleconference and will discuss compensation and whether to suspend dividend payments. Suspension or a cut in the dividend would affect millions of British and American investors. Only a few months ago, BP was Britain’s biggest company with its dividend payments accounting for almost 14% earned by UK pension funds. “BP is preparing to defer payment of its next dividend to shareholders by placing the money in an escrow account until the full scale of the company’s liabilities from the disaster can be determined, The Times has learnt. “(Times online)

If dividends are suspended, many investors would probably exit the company. I would also sell my position in BP should the dividend be cut or suspended. Since the oil spill has not been fully contained so far, the liabilities that BP faces could not be calculated. Because of this, chances are that dividend payments might remain suspended or cut even after a few years after the environmental disaster in the Gulf of Mexico.

British Petroleum could learn from the experience of Exxon Mobil (NYSE:XOM), which was deemed by the US Supreme Court to be “worse than negligent but less than malicious” after the Exxon Valdez oil spill off Alaska in 1989. Exxon eventually paid only a fraction of the $5 billion fines originally imposed, and in 2008 it reported the highest single-year profit in American history.

Full Disclosure: Long BP and XOM