Gulf of Mexico Oil Spill: Liability Payment Capacity View

by: Richard Shaw

The latest estimate of gross liability for the Gull oil spill is up to $37 billion ($15 billion to $23 billion for cleanup and $14 billion in claims) from Credit Suisse. Those numbers do not include possible punitive damages awards or fines, which one report on Bloomberg today said could be as much as $9 billion. In combination, those numbers amount to $46 billion.

Given that the numbers increase with each failed oil flow stoppage attempt, it may be reasonable to imagine that if the final solution rests solely with relief wells, the total liabilities could be a multiple of $46 billion. It might be useful to think through how BP and other involved companies could handle rough amounts such as $50 billion to $100 billion in total liability.

In our prior article, we measured the market-cap reductions for the six related companies (listed below). Inspection shows those six companies as of June 1 had lost $121 billion in market value, $84 billion of which is in excess of what they would have lost based on the down trend in the overall market.

There have been calls for nationalization, although asset seizure would be the actual result, because BP (NYSE:BP) is not a US company and does not have all of its assets in the US. There are concerns about BP's ability to remain independent, and questions about its ability to maintain its dividend.

We think nationalization or asset seizure is too far to the left to be likely in this county (at least we hope so), even considering the way the current government has handled the banking and auto industry problems. The chill that would put on all equity markets is unquantifiable, but would be extremely adverse.

We think that a takeover is entirely unlikely until the gross liabilities for BP are known and effectively walled off.

Criminal prosecution is nearly virtually certain based on the rhetoric, and punitive measures are extremely likely.

We think the dividend is definitely in play. There is a real probability that retribution, as well as remediation and recovery, will be part of the final resolution of the spill problem. In order to minimize public and government ire, BP may be rationally compelled to reduce its dividend to divert funds over to its gross liabilities. If BP continues to pay stockholders without interruption or reduction, there may be more of a risk of punitive awards than if they make some nod to the public by reducing payout. It is possible that they may have no financial choice but to reduce dividends in any event.

Let's look at some large category numbers from the financial statements of the six companies directly related to the spill.

The implicated companies:

  • BP (BP) owns 65% of the Macando prospect and is the operator, and the party with primary legal liability.
  • Anandarko Petroleum (NYSE:APC) owns a 25% non-operating interest.
  • Mitsui (OTCPK:MITSY) owns a 10% non-operating interest.
  • Transocean (NYSE:RIG) provided the Deepwater Horizon drilling rig that exploded.
  • Haliburton (NYSE:HAL) provided various services to the rig, and was cementing the well to stabilize its walls.
  • Cameron International (NYSE:CAM) provided the blowout preventer that failed.

This table presents the three-year average of sales, cash from operations, taxes, capital-expenditure, and the total current indicated dividend amount. It shows the maximum annual payment capacity of each company, assuming that each did not have to borrow money or sell assets, and that each did not make any new capital expenditures or pay any dividends until the full liability is paid.

Cash from Operations = Net Income + Depreciation + Amortization +(-) Increase (Decrease) in Accounts Payable +(-) Decrease (Increase) in Accounts Receivable +(-) Increase (Decrease) in Deferred Taxes +(-) Decrease (Increase) in Inventories +(-) Decrease (Increase) in Pre-Paid Expenses.

If you add back Taxes to Cash from Operations, you have a number which probably represents the maximum annual payment capacity of each company if (1) they make no capital expenditures which are life blood to oil companies to replace reserves, (2) they pay no dividends, (3) they do not increase borrowing to pay liabilities, and (4) they do not sell assets to raise funds to pay liabilities.

We don't know how payments of environmental cleanup and fines or punitive damages are taxed in a catastrophe under US law or the laws of other nations to which BP as a multi-national has tax obligations. It is also possible that the tax treatment of this spill could be subject to legislation that is not yet written. Therefore, showing the full amount of taxes as an add-back as cash available to pay for the liability is a best case for the company.

Note that Obama stated that "every penny" of costs will be borne by BP and not taxpayers. Any tax deduction for any spill related expenses is in effect a cost to taxpayers. For that reason, we would expect at least proposals to prevent tax deductibility for expenses relating to this spill. If that happens, it would probably become law for future spills and change the economics of the exploration and production business. There has long been a call for industries to pay for the "external costs" of their production, and this event may be the stimulus to put legislation into effect.

What portion of the gross liability can be recovered from insurance, co-owners, and subcontractors will be key to BP's future, as well as the gross amount itself and the number of years over which the payments will be made.

Holdings Disclosure: As of June 2, 2010, we do not own any securities mentioned in this article in any managed accounts.

Disclaimer: Opinions expressed in this material and our disclosed positions are as of June 2, 2010. Our opinions and positions may change as subsequent conditions vary. We are a fee-only investment advisor, and are compensated only by our clients. We do not sell securities, and do not receive any form of revenue or incentive from any source other than directly from clients. We are not affiliated with any securities dealer, any fund, any fund sponsor or any company issuer of any security. All of our published material is for informational purposes only, and is not personal investment advice to any specific person for any particular purpose. We utilize information sources that we believe to be reliable, but do not warrant the accuracy of those sources or our analysis. Past performance is no guarantee of future performance, and there is no guarantee that any forecast will come to pass. Do not rely solely on this material when making an investment decision. Other factors may be important too. Investment involves risks of loss of capital. Consider seeking professional advice before implementing your portfolio ideas.