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BP shadow on oil investments
Lack of oil investments will postpone new oil discoveries and raise oil prices

BP shadow on oil investments By MERLIN FLOWER for OIL-PRICE.NET, 2010/06/28

If the signs are directly overhead, will they be visible or invisible? That the Deep Water Horizon rig, which exploded on April 20, was leaking prior to the explosion, as claimed by an oil worker who survived to tell the tale, seem to suggest the latter. The leak in the BOP, which was the reason for the explosion, was spotted, a week before the blast, it now emerges. Also, an internal document of BP showed the company estimating the leak to reach 100,000 barrels a day/ 4.2 million gallons, in the worst case scenario, higher than what it had publicly disclosed.

On the other hand, the oil continues to gush from the ruptured well, making it the worst environmental disaster in the history of the US. BP says that it has collected 11,050 barrels of oil as of June 19. But a clear solution will emerge only after the two relief wells are completed, expected by mid-August.

Not surprisingly, share prices of BP have fallen by more than half, over 55 percent, to be precise. Prior to the disaster, the stocks were trading above $60 in New York. 83 percent of Americans, the latest poll by AP-GfK suggest, disapprove of the way BP handled the crisis. International credit rating agency Moody lowered the rating of BP by three notches to A2 from Aa2. A statement from Moody said, "Moody's updated assessment is that the spill will have a sustained negative impact on the group's free cash flow generation and overall financial profile for a number of years."

Standard & Poor, too, downgraded its rating on BP debt to AA from AA+ on June 3, which was further lowered to BBB. A statement read, 'The downgrade reflects our opinion of the challenges and uncertainties that BP continues to face in the aftermath of the explosion on the Deepwater Horizon rig.' According to another rating agency, Fitch, as of June 4, BP had $5.25 billion of bank credit lines, $5 billion of available cash and $5.25 billion of stand-by bank facilities. BP says it had over $10bn of committed banking facilities. "The recent claims by U.S. state and federal authorities that BP escrow significant sums pre-emptively, ahead of any agreed claims process, represent a material change in approach," Fitch said in a statement.

Lower rating means that it would be difficult and costly to borrow/raise cash as investors would be looking at higher returns for their increased risk. In addition, borrowing in the short term would be more expensive than in the long run. This is because investors would expect more compensation for the short term losses than the long term investments which could be subjected to more planning.

Future ratings would depend on:

  • ongoing difficulties in containing the spill
  • additional costs for clean-up, penalties, litigation, compensation and fines
  • long term consequences like pollution
  • additional liabilities the company could face
  • increase in the oil flow
  • Before the congressional committee, the CEO of BP, Tony Hayward refused to answer on more than 60 occasions which made the representatives accuse him of stonewalling the procedure. Soon after, BP Chairman Carl-Henric Svanberg announced that the CEO would no longer be managing the response to the oil spill.

    Meanwhile, President Obama stressed BP was "a strong and viable company, and it is in all of our interests that it remain so." However, he also said that company should not pay dividend instead pay for the clean-up. Adding he'll 'make BP pay' and he did just that.

    So now there is a $20bn escrow fund administered by Ken Feinberg, and active for the next three and a half years to pay for liabilities. BP has also agreed to pay $100 million to workers affected by the six-month moratorium on deep-sea drilling. According to BP, it has paid $104 million to residents of the Gulf Coast, with more than 31,000 checks issued for the 64,000 claims, as on June 19. The results came after the four hour talks between white house officials and BP executives. After the agreement, the BP board reviewed its dividend policy. The first quarter dividend payment scheduled for 21st June has been cancelled and there will be no interim dividends for the second and third quarters of 2010. BP says that it would 'consider resumption of dividend payments in 2011 at the time of issuance of the fourth quarter 2010 results,' by then the long term impacts easier to assess. Carl-Henric Svanberg said, "We regret the cancellation and suspension of the dividends, but we concluded it was in the best interests of the Company and its shareholders."

    It is estimated that his would affect about 18 million people in the UK who own BP shares or as beneficiaries of pension fund which holds BP shares. BP's dividend payment contributes £1.8bn to the UK's pension funds every three months. Many investment funds have stakes in BP as the oil giant used to be a good dividend provider. Any pension investor by default has a stake in BP. According to BP itself, the company accounts for £1 of every £7 dividend income received by pension funds from FTSE 100 companies. Thus, the dividends are important for pension funds in UK as well as in the US. In the UK, dividend payments to the tune 13% from UK Equity Income funds come from BP.

    If your investment fund has invested in BP, you stand to lose, so better check out the fund's factsheet online. One silver lining, though, is, pension funds are long-term investments with funds invested in many companies, so the prospectus are better in the long run. For an individual investor, this means that he may not receive any payment on his BP shares this year. Specifically, should an investor sell his BP shares now? Not really, if sold now the investor stands to lose as he would be locking into the losses. Ironically, there are many investors waiting to gobble up the shares with an eye on the long term prospects, and you'd be playing into their hands.

    In addition to the cancelled dividend payment, BP is planning to reduce its capital expenditure by $2bn this year and raise $10bn through selling of its assets. If BP sells its oil rig, to a Chinese company for example, there would be reduction in oil back home, as demand is increasing in China. Standard Chartered Plc. estimates that the cost of cleanup and liabilities could reach $40 billion. The fall in share price, drop in BP's market value and cut in dividends, in itself has wiped out billions off the company and its market has been value reduced to £55 billion from £120 billion. The share prices have moved to see a 14 year low.

    Amid this State Treasurer John Kennedy sent a letter to the Louisiana Governor Jindal, asking for a back-up plan for clean-up costs if BP files for bankruptcy. And, it's not just the UK, if BP's liabilities force it to bankruptcy, BP's US subsidiaries will have to pick up the tab. Here in the US, the following companies are BP subsidiaries: Arco gas stations, AmPm convenience stores and Castrol motor oil are all owned by BP. 22,800 of the over 96,000 employed by BP live in the US. No less than 40 per cent of BP shares are held in the United States.

    Though BP is the major stakeholder and operator of the Deepwater Horizon rig, other companies-like Transocean Ltd and Anadarko Petroleum, may also be asked to contribute funds for the clean-up. Transocean Ltd., is the drilling contractor of the now sunk rig, while Transocean Ltd. has a 25 percent non-operating stake in the well. In fact Anadarko Petroleum Corporation has been critical of BP saying it was "grossly negligent" and that "The mounting evidence clearly demonstrates that this tragedy was preventable and the direct result of BP's reckless decisions and actions."

    Last year, IEA had warned of underinvestment in new supplies. The agency had predicted a drop of 19% ($90 billion in 2009 from 2008) in spending on oil exploration and developing new reserves. The IEA says that the levels were inadequate to supply future needs. The BP oil spill has also triggered a wider global economic trend: the distrust of Big Oil companies by retail investors who are pulling their investments out of the energy sector at a time when investors are already wary of stock investing. And with the convenience web-based trading, this is fast and massive.

    As stated earlier, there is a six-month moratorium on deep-water exploration drilling imposed by President Obama. According to energy consultant Douglas-Westwood if the moratorium lasts two years, output in 2015 could be 400,000 barrels a day. This is 25 per cent lower than otherwise.

    A recent New York Times/CBS News poll suggest that many Americans think US needs a fundamental overhaul of energy policies but are unwilling to pay for a cess on their gas to contribute to alternative energy research. Clearly, we do need more investment for alternative energy sources but, realistically, for anything worthwhile to emerge from the fold will take time. Suspending investment on oil exploration will only add to the woes with higher oil prices. The clueless opposition to oil investments oversteps the simple question-If not oil, what?

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