BP’s Settlement Could Top $16 Billion Amid Failed Attempts To Limit Its Liabilities
BP Plc. (NYSE:BP) has made several attempts to limit the charges associated with the settlement agreement signed last year to compensate individuals and businesses for economic losses relating to the Gulf of Mexico oil spill. Recently, an independent investigation of the claims compensation process revealed certain irregularities in the form of misconduct by some officers due to conflicting interests. [1] However, the larger issue of both volume and size of the claims being processed still remains unresolved as the Judge rules out a need to halt the claims process. Based on the payments made so far and the rate at which the claims are being filed currently, we estimate the settlement agreement to cost the company more than $16 billion, which is more than double its original $7.8 billion estimate.
Since the 2010 Deepwater Horizon incident, BP has incurred costs and provisioned as much as $42.2 billion for the various charges and claims arising from the incident. This includes the $20 billion contribution to the Deepwater Horizon Oil Spill Trust fund, which was set up by the company in agreement with the U.S. government to pay individual and business claims, penalties resulting from litigation judgments and settlement of litigations, state and local response costs and claims, as well as natural resource damages and related costs. However, there are huge uncertainties associated with the amount of future liabilities that the company might have to bear, which can potentially turn out to be far more than what it has currently provisioned for.
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Settlement Troubles
BP’s oil spill expenses have swelled since it signed an uncapped agreement to compensate individuals and businesses for economic losses caused by the 2010 Deepwater Horizon incident. The company initially estimated the cost of settling a substantial majority of legitimate individual and business claims arising from the incident at $7.8 billion, and entered into an agreement with the Plaintiffs’ Steering Committee (PSC) for the same on March 3, 2012. However, along with the second quarter earning results, BP announced that it has increased the charge for the settlement to $9.6 billion to reflect higher costs of claims and litigation with no guidance on future liabilities that can arise from similar claims under the agreement.
BP blames a “misinterpretation” of the terms of the agreement by the claims administrator, Patrick Juneau, for rising expenses. The company made several court appeals this year and even launched an ad campaign challenging the administrator’s interpretation of the agreement. The matter is still sub judicious as the U.S. Court of Appeals ruling from July has yet to be announced. The courts also denied BP’s repetitive appeals to halt the process while irregularities in the claim settlement procedure are being investigated. [1] This further hurt the company’s prospects of being able to substantially limit the amount of settlement charges it might have to bear.
Some Solace
In July, the District Court appointed Judge Louis Freeh, a former director of the Federal Bureau of Investigation, to lead an independent investigation of the settlement process in connection with allegations of potential ethical violations or misconduct. The Judge submitted a report based on his findings last week, which concluded that the claims compensation process has been plagued by conflicts of interests and unethical conduct. The report that blames some officers in the administrator’s office for processing certain claims for kickbacks also suggests that there is no reason to halt the complete process. Mr. Freeh has been told to continue his role of investigating the process for potential misconduct and to claw back payments made on fraudulent claims. We believe that it will only bring some solace to the oil giant in the form of a support to its contention that there are several issues with the ongoing compensation process, as the larger issue of both volume and size of the claims being processed still remains.
Our Estimate
As of Sep 6, 2013, the claim administrator received as many as 205,434 claims of which 45,412 were denied at a rate of almost 22%. Average claim amount awarded to date stood at over $83,000 per claim. However, the rate of filing claims has declined from ~20,000 per month in June last year to below 10,000. Now, the April 2014 deadline is still seven months ahead, and therefore the total number claims can easily top 250,000 even if they are filed at an average rate of 5,000 per month. Moreover, there is also a possibility that the deadline is further extended due to pending resolution of all the legal appeals pertaining to the settlement’s validity. (See: BP’s Oil Spill Cost Uncertainties Continue)
If we go by the assumption that the average claim amount and the rate of denial will remain roughly constant, the settlement agreement could easily cost BP more than $16 billion, which is almost $6.5 billion more than the company’s revised estimate of $9.6 billion. [2]
This implies an increase in the cumulative charge of more than $8 billion, over the company’s $42.2 billion provision for all the expenses associated with the oil spill incident. It should be noted that this excludes the amount of additional charges that BP might have to bear as an outcome of the ongoing civil trial and any further claims based on the Oil Pollution Act (OPA) by the parties that did not participate in the settlement. Estimating these charges is extremely speculative, and therefore we are sticking with the guidance provided by the company on these matters.
We currently have $46 price estimate for BP, which is ~10% above the current market price.
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Notes:- BP Claims Administrator Juneau Cleared in Probe by Freeh, www.businessweek.com [↩] [↩]
- Public Statistics for the Deepwater Horizon Economic and Property Damages Settlement, deepwaterhorizoneconomicsettlement.com [↩]