Thursday, 17 June 2010 05:42

BoomBustBlog Bankruptcy Search: Focus on British Petroleum and Collateral Damage

In continuing our search for potential bankruptcy candidates (see part 1, The BoomBustBlog Pan-European Sovereign Debt Crisis Bankruptcy Search - US Banks), we would be remiss in ignoring the malaise that is currently British petroleum and their drilling partners. I have just released a report to subscribers (see end of post) laying out our empirical analysis of the probability of insolvency and default for British Petroleum and their drilling partner, APC. Below, I have included a summary for the general public.

Apart from the extreme headline risk British Petroleum faces:



There are very real potential and actual fundamental challenges facing it as well as its contracted partner, APC.

In order to estimate the probability of bankruptcy of BP and APC, we built three scenarios in which we have estimated the costs from the spill in Gulf of Mexico. While the cleanup costs are thus far being completely borne by BP (owning 65% and the current operator of the leaking well), the share of losses of APC (owning 25% in the leaking well) and Mitsui (owning 10%) will arise when BP contests for loss sharing in the courts. Since APC and Mitsui are only the financial owners with no strategic and operating interests in the leaking well, legal experts are giving a strong possibility that APC and Mitsui might escape most of the spill costs if it is proven that the explosion was largely owing to the negligence on the part of BP. Thus, for this initial qualitative portion of our analysis we assume the entire costs currently being borne by BP.

We have built three scenarios with varying assumptions about the flow rate and capture rate of the containment ships to arrive at the amount of oil that will be released till August 1, 2010 (scheduled date for completion of relief wells). Please note that the flow rate and capture rate assumptions are on the basis of the latest reported figures by government scientists and BP (who has a perverse incentive and conflicted interests). The actual flow rate and the capture rate are still uncertain. The average cleaning costs per barrel and the litigation and punitive damages estimates are based on analyst estimates.

The total estimated spill cost is $40.5 billion, $73.9 billion and $107.2 billion under optimistic, base and adverse case, respectively. The amount of losses already discounted in the prices is nearly $67.9 billion (not taking into consideration the very recent pop in the stock price) which is the difference between the current market cap and the market cap based on fair value per share using peer average 2011e P/E multiple.

We modeled the estimated spill costs in the projected cash flow position of BP over the next four years and it is observed that although the spill costs will result in excessive liquidity pressures in 2010 forcing BP to cut down on dividend and capex and raising fresh debt, the possibility of bankruptcy will arise only if BP is not provided the required funds. It should also be noted that it is our understanding that bankruptcy will probably not expunge BP’s liabilities in regards to cleaning and rehabilitating the environment damaged by the spill. Based on the cash flow projections in which we have assumed cancellation of dividend in 2010 and cut down of capex by 50%, the total free cash flows in 2010 under Base case and Adverse case are -$40.4 billion and -$70.9 billion. Apart from any new debt requirements, BP also will need funds to refinance its maturing debt of nearly $1.3 billion and $6.0 billion in 2010 and 2011, respectively. BP has credit facilities of nearly $5 billion.

Thus, the survival of BP will primarily depend on availability of funds from the market (and barring a significant blowup stemming from the expanding Sovereign Debt Crisis) and the uncertainty around the spill costs will make the funding difficult.

Financial Analysis

All figures in $ billion except per share data

Spill cost estimates (in $ billion) under each case

Optimistic case

Base Case

Adverse Case

Clean up costs

xxx

xxx

58.3

Fines under Clean water Act

xxx

xxx

26.4

Compensatory

xxx

xxx

6.7

Punitive

xxx

xxx

19.6

Other compensatory and punitive damages

xxx

xxx

22.5

Compensatory

xxx

xxx

11.3

Punitive

xxx

xxx

11.3

Total spill costs

xxx

xxx

107.2


All figures in $ billion except per share data

Estimated Spill costs

Total estimated spill costs

BP's liability

APC's liability

Mitsui's liability


 

 

 

 

Base Case

xxx

xxx

xxx

xxx

Adverse case

107.2

80.5

19.1

7.6

Optimistic case

xxx

xxx

xxx

xx

06:37

Subscribers (click here to subscribe or upgrade), please download the full analysis below:

Last modified on Monday, 21 June 2010 14:37

9 comments

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  • Comment Link Zhang Fei Sunday, 27 June 2010 15:23 posted by Zhang Fei

    What about the possibility that BP is too big to fail? It's the most profitable UK company, and the second most profitable UK company. If the EU goes to bat for BP, I'd expect US government claims to shrivel dramatically.

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  • Comment Link shaunsnoll Monday, 21 June 2010 13:00 posted by shaunsnoll

    intersting to see risk assets rallying so strong today, seems overdone. china relaxing their currency controls not likely to be hugely positive for US junk bonds for example, which are rallying today.

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  • Comment Link squashnut Monday, 21 June 2010 07:25 posted by squashnut

    How do you estimate "other compensatory and punitive damages"? [15-22.5 BB] I think the OPA '90 liability cap will not survive a "gross negligence" claim. Some plaintiffs' damages will be too remote, but punitive could be huge. These could be assigned by Gulf jurors...

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  • Comment Link Reggie Middleton Monday, 21 June 2010 07:15 posted by Reggie Middleton

    Well, to begin with, the worse case scenario just got worse: http://www.cnbc.com/id/37819082

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  • Comment Link squashnut Monday, 21 June 2010 07:13 posted by squashnut

    What about the cost of doing oil drilling going forward? Negative brand image in the US affecting sales?

    The US military doesn't need or care about BP. It only cares about oil. I'd be very careful in assigning an "adverse scenario" number-- especially until the well is actually capped.

    Reggie: any thoughts about BlackRock with I believe 1.1 billion shares of BP? That's a fat writedown. [Disclosure: I have BP puts]

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  • Comment Link NDbadger Sunday, 20 June 2010 00:16 posted by NDbadger

    Seems like one should really be debating whether BP is a good long or not.

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  • Comment Link Seal Friday, 18 June 2010 11:18 posted by Seal

    BP will be protected as it is the largest supplier to the US military – the world’s largest user of petroleum and, hence, the world’s largest polluter.

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  • Comment Link shaunsnoll Thursday, 17 June 2010 10:41 posted by shaunsnoll

    this will be in court for decades and I would be surprised if in the end BP didn't get their ultimate fine reduced quite a bit just like XOM in the Valdez spill.

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