I love Friday news stories. While many people in the investment and trading community head out long before the end of the day on Friday, for those who follow the news closely, every Friday afternoon usually has at least one interesting news story. One of the reasons for this is because politicians and companies often dump what they perceive as their least favorable stories into the news cycle at the end of the week.
While not all stories can be so conveniently pushed under the rug, and the settlement process involved with cases like the recent Department of Justice settlement with Mitsui is always complicated, I think it is worth noting the timing of the release of the government's decision. While most sectors have rallied considerably during the last nearly five month rally now, oil drilling stocks have lagged most full-service oil service companies and oil producers. Despite the run-up in oil and improvement in the economic outlook these driller have continued to be hurt by the over-supply of rigs, difficulty obtaining new permits, and uncertainty surrounding the cost drilling projects.
Drillers like Transocean (RIG), Diamond Offshore (DO), and others, have faced enormous uncertainty over the last year. In addition to the fact that many rigs have been down and difficult to move out of the Gulf after the spill, day rates for the rigs have also been hurt by the over-supply of rigs. The cost of insuring rigs and the willingness of oil companies and financial backers to support new drilling projects in the Gulf has also been unclear since new permits have been hard to come by in this region.
As an attorney it is interesting to look at both the business and legal ramifications of the recent settlement. Mitsui is a Japanese company that held a 10% stake in the Macando well. For the last several years the Obama administration has been walking a tightrope between its environmentalist backers and the oil industry. While the press has set up the story as environmentalists against big oil, many individuals working on rigs and in industries tied to the Gulf have been affected by this story as well. I think this is why the administration's decision on an issue like this in an election year is so important.
Under the Oil and Pollution Act, Obama could have sided with the environmentalist lobby and sought punitive damages against BP and its partners, Anadarko and Mitsui, to the tune of 10 billion or more. The courts already ruled that BP and its partners could not limit their liability under the Oil and Pollution Act, and obviously most juries would not have been very sympathetic to the side of BP and their partners.
Given that the per day estimates on the number of barrels of oil that was leaking into the gulf during the first several months after the spill was between 52,000-62,000 barrels a day, BP and their partners could have faced up to 10 billion or more in fines under current federal law. This is because the Oil and Pollution Act enables the government to seek fines based on the amount of oil that was dumped in the gulf. Mitsui, as a 10% equity holder in the Macando well, could have been held liable for a billion dollars or more in fines and damages. The Government's choice: settle with Mitsui for 90 million.
While it would be too simple to just pro-rate the government's decision to Anadarko and BP and suggest that they will pay 225 million and 570 million based on their respective shares in the same well, since Mitsui was not involved with the decision-making process on the deepwater Horizon Rig, this decision is still very important. This is because the Department of Justice's very industry favorable resolution signals that the government has taken an pro-oil and pro-jobs stance in their approach to the liability question in the gulf. The government has definitively big oil and the people they employee rather than the environmentalist lobby. This is exactly I think the White House chose to announce the settlement on a Friday afternoon.
Now, obviously, the simple view would be that since the government will settle with Mitsui, their likely similarly small settlements with BP an Anadarko would be good for those respective stocks since their liabilities under the Oil and Pollution Act will also be similarly limited. But, I think, a decision like this is good for the whole industry for broader reasons.
Now that the courts have recently upheld Transocean's (RIG) indemnity contract with BP and the Department of Justice has clearly sent a signal that it will take very industry-favorable position on the liability question involving oil spills, the cost of exploration and production in the gulf should be significantly lower over the longer-term. The issuance of new permits and extension of existing ones for exploration may very well also increase in the future.
With the prospect of a large multibillion-dollar government suit all but eliminated, the cost to insurance rigs and the willingness of lenders to support new drilling and exploration projects should markedly improve. This should pave the way for new and increased investment by the Exxon's (XOM), Chevron's (CVX), and other major players in the gulf. Oil drillers like Transocean and oil service companies like Halliburton (HAL) an Schlumberger (SLB) should be big beneficiaries as well. The Administration willingness to extend exploration permits and issue new ones should improve as well.
To conclude, just a week ago, analysts were split on whether or not the Department of Justice would pursue a potentially devastating multi-billion dollar lawsuit against BP and their partners. Today that concern is all but gone. Oil prices are now over a hundred dollars a barrel with an election coming up, and Obama likely to continue to move to the center, so this latest settlement may also signal a new willingness of the current administration to work with Republicans on energy issues.
Well drillers like Diamond Offshore and Transocean will likely benefit the most since they are the most tied to the gulf, most drillers should benefit from the diminishing supply of rigs world-wide as the Gulf opens back up for new exploration projects. Indeed, while many S&P 500 (SPY) companies and oil producers already had huge runs over the last now nearly five month, the drillers offer strong growth and value with the possibility of significant future dividend payouts.