Shares of BP (NYSE:BP) fell almost 3% on Wednesday after it emerged that the US Government plans to aggressively pursue charges of “gross negligence and willful misconduct” against the oil giant relating to the Deepwater Horizon spill in April 2010. The company still trades at around one-third below its pre-spill price, and this recent development puts its already precarious position in even greater risk.
The allegations of gross negligence against the company are supported by findings that BP, along with Deepwater platform Transocean Ltd., made errors in interpreting the results of a crucial pressure test.  The company, however, believes that it is not guilty of the charge and will provide evidence to support its claim during the upcoming trial in January 2013.
- BP Q4 Earnings: Profits And Cash Flows Suffer Due To Low Oil Price Environment, Company Focuses On Cost Cutting
- By What Percentage Can BP’s Revenues Grow Over the Next Five Years?
- What Has Led To More Than A 30% Decline In BP’s Revenues & EBITDA In The Last Five Years?
- How Has BP’s Revenue Composition Changed In The Last Five Years?
- What’s BP’s Fundamental Value Based On Expected 2015 Results?
- What’s BP’s Revenue & Earnings Breakdown In Terms of Different Products?
The company’s woes have been further compounded by dismal results for the second quarter of this year, in which the performance was hit by declining production and an asset writedown of over $2 billion.
Company May be Liable to Pay $21 Billion in Penalties
If found guilty, BP may be required to pay around $21 billion in penalties based on US Government estimates that 4.9 million barrels were leaked during the spill. According to the Clean Water Act, if the company is found guilty of gross negligence, it must pay around $4,300 per barrel leaked. Even by the company’s own estimates of around 2.7 million barrels leaked, a guilty verdict would expose it to penalties of around $12 billion.
BP has already set aside around $38 billion for costs relating to the oil spill. However, this amount accounts for only $3.5 billion in penalties related to the Clean Water Act.
Another possibility is an out-of-court settlement between BP and the US government. BP is willing to pay $15 billion to compensate for all damages, while the US Government expects $25 billion. 
BP may face further spill related costs after waves caused by Hurricane Isaac uncovered tar balls deposited on Gulf of Mexico beaches. The company claims that while some of the tar deposited may be from the spill, the remaining could be from other oil rigs off the coast as well, although it has also expressed that it is ready to remove any tar deposited if there is solid evidence that the tar is from Mocando. 
We have currently accounted for around $41 billion in spill related expenses for our BP price estimate. This includes around $27 billion incurred in 2010 and 2011, and $7.8 billion to be distributed among fishermen and other private plaintiffs affected by the spill . The worst case scenario ($21 billion in penalties related to this act if found guilty) would add an additional $17.5 billion to these expenses, given that we have already accounted for $3.5 billion in expenses related to this. This would lead to a downside of almost 10% to our price estimate.
Our calculation of the price estimate does not factor in the impact on BP’s reputation if it is found guilty of gross negligence. The company is currently in the process of selling its 50% stake in the TNK-BP joint venture for an estimated $30 billion.  The venture accounts for around one-third of its total oil production. If it sells its stake in the venture, it will be all the more reliant on its operations in the Gulf of Mexico. A damaged reputation there may cause irreparable damage to its long term prospects.
We currently have a Trefis price estimate of $50 for BP, which is almost 20% above the market price.Notes:
- Deepwater Horizon: BP accused of gross negligence, BBC News, September 2012 [↩]
- BP seeks %15bn spill settlement, FT, June 2012 [↩]
- Louisiana looks for ‘smoking gun’ to link Isaac tar balls to Gulf oil disaster, The Guardian, September 2012 [↩]
- BP’s $7.8 billion Gulf spill pact wins initial court OK, Reuters, May 2012 [↩]
- BP considers selling its stake in TNK-BP, Bloomberg Businessweek, June 2012 [↩]