BP in Deep Trouble

Jun.22.10 | About: BP p.l.c. (BP)

We have received a lot of questions recently about BP.

  • Is BP oversold?
  • Will there be a short-squeeze?
  • Is the cost of the disaster accounted for in the stock price?
  • Is now the time to buy, since everyone is running scared?

Is this a wonderful, investment opportunity, or is BP going down faster than a burning rig? In order to assess the potential we’ll take a look at the true scope of the catastrophe, and to do that we need to put it into terms that we understand. We’ll take a look at the two key players’ responses, the government’s and BP’s. Finally, we will pull it together with last Thursday’s Congressional hearings, to see how this looks as an investment.

The Deepwater Horizon rig blew on 20 April, killing 11 people. By now, the absolute breakdown of procedure and leadership is not questioned. BP failed miserably. Not to be insensitive to the loss of human life, but that liability is a known quantity and was immediately priced into the stock. But just how large is the gusher, and what are the potential liabilities associated with its lawsuits and clean-up?

As of now the well blew 62 days ago. The initial flow rate of petroleum was estimated by BP at a farcical 1,000 barrels (BBL) per day. Since then, the estimate has been revised to the latest number of 65,000 BBL per day, but I believe the rate is even greater. My opinions aside, we’ll use the official estimate.

There are 42 US gallons per BBL of oil. At 65,000 BBL per day, oil is flooding into the Gulf of Mexico at a rate of 2,730,000 gallons per day, or 10,920,000 quarts/day. I am converting this to quarts so we can grasp this flow. The average automobile requires 5 quarts per oil change. Most cars drive 12,000 miles per year, and, if you are maintaining your car properly, will require an oil change every 3,000 miles. That is 4 oil changes per year, or 20 quarts of lubricant per car per year. The gusher, at 10,920,000 quarts per day, is dumping as much oil as 546,000 worth of annual oil changes per day. Since it has been going for 59 days, it has dumped as much as 32,214,000 worth of annual changes into the Gulf.

The most populous state is California, with a current population of about 37 million. At current flow estimates in the Gulf, in less than 6 days the gusher will have spilled as much oil as every man, woman, and child in California owning a car and changing its oil for a year. Can you picture that? Think about every person in the entire state of California owing a car, changing its oil 4 times per year, and dumping that spent oil into their front yard. To put a little more perspective on this, if you were to dump 20 quarts of used motor oil into your yard your property would officially be a hazmat site. You would likely need to spend between $250,000-500,000 to recover it. I chose California for this thought experiment. If I would have chosen Texas, the second most populous state, we wouldn’t be waiting 5.7 days to hit this mark, it would have happened two weeks ago.

I briefly mentioned before that I do not agree with the new, official flow estimate. Without getting too deep into it, the scientists that I trust are estimating the flow to 85,000 BBL/day. The total population of the United States is 307,000,000. At the flow rate that I think is more accurate, it is equivalent to every person (not every household, but every person) in the entire United States dumping over 2.6 quarts of oil in their front yard (as of today, and there is no stop anywhere in sight). If you were caught dumping 3 quarts of oil on the beach, what would the fine be? $1,000 perhaps? Well take that and multiply it by 307 million. That equals $307 billion.

These numbers are astonishing, aren’t they? The true enormity is masked behind units of measurement we do not associate (Barrels), huge numbers (tens of thousands per day) and also some more insidious tricks and lies.

I believe the most sinister lie to date has been BP’s initial flow estimate: 1,000 BBL/day. That flow rate is equal to 42,000 gallons/day. That number is so small it would be laughable if this were a joking matter. For comparison, I have an 85 gallon fish tank in my living room. 85 gallons is a large one, but for fish-tank-aficionados it is considered moderately small. The circulation pump I have on my tank is capable of moving 86,400 gallons per day. This pump can be held in one hand, it uses 180 watts of electricity, runs cool, and is whisper silent. Yet, somehow BP was claiming that my fish tank pump was moving double the fluid of their 25,000-feet deep oil reserve.

It is clearly evident that BP is attempting to hide and obfuscate the reality. We know how bad the situation is at this moment, but are they also hiding the direness of a solution? To answer that, we need to take a look at the environment in which they are working. What is the pressure like at 5,000 feet? I do not even know how to articulate that in everyday terms. I can tell you that the strongest military submarine in the world, the titanium-hulled Soviet K-278, hits its crush depth at 4,500 feet below sea level. It would not even be able to get close to the wellhead, which is 5,000 feet below the surface. Keep in mind that the deposit is another 20,000 feet below the wellhead.

This very well may be the worst case scenario: a damaged down hole 5,000 feet below the sea. That means they will never cap it. Never. They are not even trying any longer. The flow from this is too high to capture. You are probably witnessing the greatest environmental disaster in mankind’s history.

The enormity of this disaster and the alarming brazenness of BP’s cover-up brings into focus the other key player, the US Federal Government. We can talk ad infinitum about who is culpable in not helping prevent this, but once it did happen, why was the government allowing BP to put out such a whopper of a cover story? Didn’t they realize that BP has so many motivations to attempt to minimize the perception of the impact? The only thing I can conclude from this is that government has not a single, intelligent “expert” with any influence within this administration. Like the night of the blowout, we are witnessing, real time, utter failure of leadership. I am indifferent as to whether President Obama is mad or empathizing with the people of the Gulf coast, but I would like an official acknowledgement of the severity; some honest, intelligent communication; and centralized, streamlined crisis management. These people (government) are the ones that are supposed to be protecting your interests in the face of conflict with BP. You’re in trouble deeper than the gusher.

Let’s take a look at the Congressional hearing from Thursday. The CEO of BP, Tony Hayward, essentially asserted his 5th Amendment Rights against self incrimination. This seemed to be irksome particularly to the chairman of the House Committee on Energy and Commerce, Henry Waxman. Did anyone let Waxman know that Hayward is under investigation by the Attorney General Eric Holder in addition to at least 4 state attorneys general for criminal negligence? I am going to go out on a limb here and guess that Waxman grasped this obvious fact, and that the entire dog-and-pony show Thursday was nothing more than a smoke screen for the good people back home. Meanwhile, the Coast Guard is detaining oil skimming barges for 24 hours, as they check to make sure there are life jackets and fire extinguishers on board.

To return to our original questions about BP as an investment, now that we can somewhat grasp the magnitude of this disaster. BP is lying to you, and they have proven 100% incapable of taming the beast they have released. The only thing BP has shown competence in with regards to this disaster is controlling the Administration and the message. To hold BP accountable could mean seizure of decades of their profits. If you consider it unlikely that the Administration, Congress, and Courts will be unable to hold BP culpable, then this may be value investment some months from now.

I don’t feel comfortable betting that a company will be able to wreak mass destruction and not suffer the accountability. I also think this calamity will develop to a massive scale not yet officially communicated. For those reasons, I am giving this company a wide berth.

Disclosure: The adviser’s clients do not have long nor short positions in BP. Certain Belray clients do have a long position in BP.