For BP, a $20 billion drop in a very large bucket

Stock analyst: "The U.S. government will become insolvent before BP does"

Published June 17, 2010 8:21PM (EDT)

BP holds enough oil in its reserves to single-handedly supply the United States for two years. It has little debt for a company of its size and makes more money than Apple and Google combined.

So when the White House arm-twisted its executives into setting aside $20 billion for the Gulf oil spill, investors weren't worried it would bankrupt BP. They barely batted an eye.

"The U.S. government will become insolvent before BP does," said Bruce Lanni, a stock analyst with Nollenberg Capital Partners.

Sure, BP stock has crumpled in half in a matter of weeks. Creditors are demanding ever higher interest. But this time it's not some inscrutable, high-flying Wall Street bank in trouble.

BP posted $17 billion in profit from its vast operations around the globe last year, compared with $5.7 billion for Apple and $6.5 billion for Google. More important, in the past three years the company generated $91 billion in cash flow from operations.

It's not highly leveraged with debt, as banks were during the financial crisis. And it has 18 billion barrels of oil in proven reserves, twice what the U.S. consumes every year.

BP has spent about $1.8 billion on the spill so far, but that's the first drop in a very large bucket. If BP faces criminal charges, for instance, it could end up having to pay tens of billions in legal costs alone.

Analyst estimates of BP's total cost range from $17 billion to $60 billion. If the worst predictions about the leak come true, that figure could surpass $100 billion, based on a Goldman Sachs estimate that each barrel of oil spilled could wind up costing as much as $40,000 in cleanup and compensation.

Such a big bill, even at the lower end of the estimates, would drive many companies under. But analysts said BP probably won't have to go to that extreme unless it wants to wall off liabilities from the rest of its operations to attract potential suitors.

Under Wednesday's deal with the Obama administration, BP will suspend its dividend for the rest of 2010, freeing up $8 billion. The company also plans to raise $10 billion from selling some assets. Add cash lying around in bank accounts and in short-term investments and BP could raise $25 billion without breaking much of a sweat.

What's more, BP is expected to generate $30 billion this year in operating cash flow, assuming oil prices don't fall. Investors like to focus on this figure because, unlike profits, it ignores costs for which money never changes hands, like wear and tear on rigs.

Much of this operating cash has to be plowed back into the company, but some of that spending -- $21 billion last year -- is discretionary and could be cut. On Wednesday BP said it will trim planned outlays this year by $2 billion.

BP also has relatively little debt for a company of its size. That means it has plenty of wiggle room to borrow. In fact, it already has lined up $10 billion with banks if it needs it.

The caveat: If BP did need to issue bonds or take out a loan, it would have to pay above-market interest rates because the risks posed by the oil spill have tainted its credit rating.

Fear of the unknown has taken a toll on BP's stock.

With BP's deepwater well in the Gulf of Mexico still spewing oil two months after it exploded, trying to guess how much the company will have to cough up for cleanup and damages seems a fool's game.

And after watching other seemingly impregnable companies collapse over the past two years, investors are not in the mood for much uncertainty.

"We are living in an era where there is no such thing as too big to fail," said Stephen Leeb, president of the money manager Leeb Group. That specter, he said, makes BP "very scary" to investors.

BP's agreement to the $20 billion fund -- and President Barack Obama's pledge that the company is strong and should remain so -- seemed to calm investors a bit. But they still fret about BP's total tab.

Fresh estimates warn that as much as 2.5 million gallons of oil a day have been leaking into the Gulf -- triple what scientists thought just a week ago. Worried that BP is more likely now to stiff its lenders, Fitch Ratings recently knocked BP's credit score down six notches to triple B.

BP's stock price has plunged 46 percent since the April 20 explosion, wiping out $87 billion in shareholder wealth. It's more than most pessimistic stock analysts expect the company will have to pay.

And that's got some of them quite animated.

"It's overdone," said Philip Adams of Gimme Credit. Fadel Gheit of Oppenheimer & Co. captures BP's stock performance in one word: "Ridiculous."

Gheit predicts BP shares will hit $55 by the end of the next year, up nearly 75 percent from where it was trading Wednesday. Before the explosion, BP's stock was at about $60, valuing the company at $187 billion.

But despite BP's enormous wealth, even bulls worry its stock might fall further.

Among their concerns:

-- A sharp drop in oil prices.

Oil falling from $75 per barrel to $60 or $55 "would be far more destabilizing to the company than any potential claim it might face in the Gulf," Oppenheimer's Gheit said. BP's annual cash flow fluctuates by $450 million for every $1 change in oil, he estimated.

If oil prices fell, BP would be more likely to explore selling itself to Exxon Mobil, Royal Dutch Shell or Chevron or at least divest its U.S. operations, analysts said.

-- Washington could restrict BP in the U.S.

BP's willingness to set up a compensation fund seems to have converted Obama into more of an ally than an antagonist. On Wednesday, the president called the company "strong and viable," adding that it was "in all our interests that it remain so."

But there's still a risk that political backlash could restrict BP's operations in the U.S. and reduce its government contracts.

Though it operates in more than 80 countries, BP is heavily dependent on the U.S. Forty percent of its assets are in the country, and the company is the biggest energy provider to the U.S. military.

"If the government has a single-minded focus to be punitive, it could take this company down," said Lawrence Goldstein, a director of the Energy Policy Research Foundation.

Alex Morris of Raymond James said he expected politicians to be careful meting out punishment because the dependency is mutual, given the country's oil addiction.

"We're not going to ban them from the Gulf," he said, noting that BP is the biggest producer there. "It's hard to imagine our politicians telling them to pack their bags."

-- Hurricane trouble.

If BP doesn't plug the leak soon, it runs the risk that a big storm during hurricane season will wash more oil ashore and add to damages, said Argus Research analyst Phil Weiss.

For bulls on BP stock, the company's greatest asset may be time.

Cases involving major companies tend to drag on for years in the labyrinth of the U.S. legal system, and the complexity and stakes involved in the Gulf spill probably will lengthen the process even more. With more time to pay, BP can stagger its costs instead of absorbing them all in a single financial blow.

"I would be stunned if all the criminal and civil cases against BP are wrapped up before the end of this decade," said David Logan, dean of Roger Williams University's School of Law in Rhode Island.

BP may be able to stretch out payments even longer, if the Exxon Valdez spill is any measure. The tanker spilled 11 million gallons in Alaska in 1989, but it took nearly two decades for the courts to determine what the company had to pay.

Said Raymond James analyst Morris, "Anytime you have lawyers billable by the hour, you know it's going to drag out."


Associated Press writers Harry Weber in Houston and Mark Williams in Columbus, Ohio, contributed to this report. Liedtke reported from San Francisco.

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Gulf Oil Spill