BP’s Oil Spill Liabilities Could Rise Sharply As The Court Finds It Grossly Negligent
A U.S. federal judge has ruled that BP Plc. (NYSE:BP) was grossly negligent in the lead-up to the 2010 Deepwater Horizon incident. This could increase the London-based oil and gas giant’s total liabilities by as much as $14.5 billion. The company has come out with a statement expressing strong disagreement with the verdict and plans to immediately appeal to the U.S. Court of Appeals for the Fifth Circuit. [1]
Headquartered in London, BP is one of the world’s leading oil & gas multinationals with operations in more than 80 countries. As a vertically integrated oil and gas major, it has both upstream as well as downstream operations. The upstream division primarily includes exploration and production activities for oil and gas, while the downstream division focuses on producing refined petroleum products such as gasoline.
We currently have a $54 price estimate for BP, which we will revise based on recent announcement.
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Since the Macondo well blowout in April 2010 that killed 11 workers and resulted in millions of barrels of oil being spilled into the Gulf of Mexico, BP has incurred costs and provisioned as much as $43 billion for the various charges and claims arising from the incident. The company has already shed assets worth over $38 billion to fund these liabilities and is in the midst of a program to sell another $10 billion worth of assets by the end of next year. We believe that a sharp increase in BP’s oil spill liabilities can prompt the company to pursue further asset disposals, which could weigh on its turnaround plans significantly. Below, we assess the impact of additional liabilities as a result of the recent ruling on the company’s stock price.
BP’s potential liabilities from the Clean Water Act primarily depend upon the court’s view of three key aspects in the ongoing lawsuit. First of all, the liabilities depend upon whether or not the court finds BP grossly negligent for its actions surrounding the spill, as this defines the maximum limit to the per barrel fines to be charged by the government. According to the Clean Water Act, the U.S. government can seek fines up to $1,100 per barrel of oil spilled on a finding of strict liability. However, if the company is found to be grossly negligent, the fines can go up to $4,300 per barrel of oil.
Based on the recent ruling, which found BP to be grossly negligent, the company’s potential liabilities from the Clean Water Act can go up to as much as $18 billion depending on the court’s view of the other two key aspects. These include the amount of oil that was spilled during the 87 days it took BP to cap the leaking well and the size of per barrel fines, which depends upon the court’s assessment of 8 penalty factors including the degree of fault and attempts made by the company to fix the damage. The court has not ruled on the amount of oil spilled so far and is scheduled to hear testimony on the 8 penalty factors January next year.
BP estimates that around 2.45 million barrels of oil were spilled in the Gulf of Mexico, net of the amount of oil captured on the surface. However, the U.S. Department of Energy estimates the net discharge of oil in the Gulf to be around 4.2 million barrels. The company has currently provisioned $3.51 billion for potential penalties under the Clean Water Act. The provision is based on its own initial estimate of the amount of oil spilled in the Gulf and the assumption that it would not be found grossly negligent in the whole incident. [2]
However, if BP were to face the maximum per barrel fine of $4,300, its Clean Water Act liabilities could rise to anywhere between $10.5 and $18 billion depending upon the amount of oil spill taken into account. In this scenario, the company’s liabilities could increase by $7-14.5 billion. The post-tax impact of this escalation in liabilities on the company’s valuation could range between $5.3 and $11.0 billion by our estimates. This translates into a per share (American depository share) negative impact of $1.60 to $3.30.
It should also be noted that the overall impact of this scenario on BP’s valuation could be much higher since the above assessment does not take into account the fact that if not for funding additional liabilities, the company can actually use its assets to grow earnings and shareholder contributions. The company’s shares fell by $2.82 or 5.9% after the court’s ruling came out on September 4th.
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Notes:- ‘Worst Case’ BP Ruling on Gulf Spill Means Billions More in Penalties, bloomberg.com [↩]
- BP 2013 Annual Report, bp.com [↩]