BP’s Downside Risk From Climbing Oil Spill Expenses
Since the 2010 Deepwater Horizon incident, BP Plc (NYSE: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 setup 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. In this article, we discuss some of these uncertainties in light of the current provisions made by the company and will also be looking at the potential impact of some of the possible outcomes on its stock price.
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What If BP Is Proved Grossly Negligent?
BP is facing a civil trial in the U.S. that will determine the amount of fines that the company would be liable to pay under the Clean Water Act. According to the act, a firm is liable to pay up to $1,100 per barrel spilled if the company is found to be simply negligent. However, if the company is found to be grossly negligent, the fines can go up to $4,300 per barrel spilled. Initially, there were different assessments of the U.S. government and BP on the volume of oil spilled in the incident. According to the U.S. government’s assessment 4.9 million barrels of oil was discharged from the well before it was sealed. However, BP argued that it was able to recapture 810,000 barrels directly from the broken wellhead so these should not be considered while calculating the volume of oil spilled. Just a week before the crucial hearing over the Clean Water Act earlier this year, the U.S. government agreed with BP, reducing the amount of maximum fine that can be levied on the company under the act by more than $3.4 billion. [1]
Although the amount of oil spilled in the accident has been reconciled with the U.S. government, huge uncertainty associated with the case still remains. BP has currently provisioned $3.5 billion for the penalties associated with the Clean Water Act under the assumption that it would not be ruled as being grossly negligent. However, if the outcome of the case goes against this assumption, BP’s oil spill expense can significantly escalate. If the court enforces the maximum, $4,300 per barrel fine on BP, it can result in additional $14 billion charges to the company, which will be over and above the amount BP has already provisioned for these penalties. [2]
Not only this, it will also result in punitive damages to claimants who were not a part of the settlement agreement that BP struck last year with most individuals and other private party plaintiffs. Estimated at $7.8 billion initially by BP, the settlement excluded claims of financial institutions, casinos, private plaintiffs in parts of Florida and Texas, federal government claims and those of Gulf Coast states of Louisiana and Alabama. Claims from these parties can cause BP’s oil spill bill to climb further. The company stated earlier this year that the states of Alabama, Mississippi, Florida and Louisiana are claiming at least $34 billion in damages. [3]
Rising Settlement Claims
On March 3, 2012, BP announced that it had reached an uncapped settlement agreement with the Plaintiffs’ Steering Committee (PSC) to resolve a substantial majority of legitimate individual and business claims arising from the incident. Initially the company estimated the cost of the settlement at $7.7 billion. However, it seems that the company will have to shell out a lot more going forward as the company admitted in its 2012 annual report. The company noted that claims related to business economic losses were being paid out at a significantly higher average amount than previously estimated, as per its interpretation of certain protocols established in the economic and property damages settlement agreement. It reached out to the court with its position, but the court upheld the claims administrator’s interpretation of the agreement on March 5th 2013. BP says that it “strongly disagrees” with the ruling and intends to pursue all available legal options to challenge it. [4]
As of Jun 18, 2013, the claim administrator received as many as 177,484 claims of which 31,743 were denied at a rate of almost 18%. Average claim amount awarded till date stood at over $80,000 per claim. Patrick Juneau, the settlement claims administrator told Reuters that he expects a surge in claims as the April 22, 2014 deadline comes closer. He also said that he expects total number of claims filed to top 200,000. [5] If we assume that the average claim amount and the rate of denial will remain constant, and if the number claims that would be filed is assumed at 200,000, the settlement agreement could cost BP $13.1 billion, which is almost $5.5 billion more than the initial estimate. [6]
Downside Risk To Our Estimate
Based on the available information, we have accounted for a cumulative charge of $47.7 billion associated with the oil spill incident, as we expect the partial settlement claims to be higher than initially expected by the company. However, assigning any amount to the outcome of the civil trial and any further claims based on the Oil Pollution Act (OPA) by the parties that did not participate in the settlement would be extremely speculative and therefore, we are sticking with the guidance provided by the company on these matters.
It should be noted that the worst-case scenario for BP in this case would be if it is proved grossly negligent, is charged with punitive claims of $34 billion by the four Gulf States and is also unsuccessful in challenging the court’s ruling on the interpretation of the partial settlement agreement. Under this scenario, its cumulative oil spill charges can go over $95 billion, which will imply a downside of almost 25% to our current $47 price estimate for the company.
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Notes:- BP Wins Approval to Cut Potential Fine by $3.4 Billion, www.bloomberg.com [↩]
- BP Seeks to Prove Gulf Spill Errors Weren’t Negligence, www.bloomberg.com [↩]
- Claims may push BP’s spill bill to $90bn, www.ft.com [↩]
- Company Annual Report 2012, www.bp.com [↩]
- Official set for surge in BP spill claims as deadline nears, reuters.com [↩]
- Public Statistics for the Deepwater Horizon Economic and Property Damages Settlement, www.deepwaterhorizoneconomicsettlement.com [↩]