Yes, BP is a buy

14th July 2010

Tuesday's news, to the effect that the company has succeeded in putting a secondary cap on the Macondo oil spill, as this announcement shows, has given the BP share price a significant boost.

And investors are continuing to keep a close on eye on the share price as well as who is buying BP shares, as the thread on moneysavingexpert.com among others (see link under FROM OTHER SITES) shows.

It's also reinforced the feeling on the community boards that the physical side of the crisis may be approaching what Winston Churchill might have called "not the beginning of the end, but perhaps the end of the beginning".

By Tuesday afternoon BP's shares had risen by 4% to 415p – the twelfth consecutive increase since the price bottomed on 29th June at 303p.

And in the process it confirmed our forecast that the company has been wildly underpriced since it became America's favourite whipping-boy back in April. 

There's more to all this than meets the eye, however. For one thing, BP's long-term liabilities in respect of the Deepwater spill are still unquantified, because nobody knows yet how many aggrieved coast-dwellers will eventually turn up to stake their compensation claims.  

Meanwhile the legality of some of President Barack Obama's early measures is being cast into doubt by the American courts – such as his decision to order a national deep-water drilling moratorium which was scheduled to cost BP damages for every day of its enforcement.  

In short, we don't have all the information we need to make an informed decision. And that's our gamble. So far, it's paid off to the tune of a 33% profit. Will it continue? 

PR nightmare 

Well, nobody ever said it was going to be easy to placate an outraged American nation that's suffering the worst maritime environmental disaster in its history.

But BP's leadership has made quite a success of messing it up. Was it really necessary to play a bad hand of cards so very ineptly? 

Let's recall the gruesome timeline.  

Chief executive Tony Hayward opened the bidding back in May, by insisting that the leakage from the Deepwater Horizon spill was ‘minor'.  

Then, when it started to look worse, he rashly told Fox News: ‘I'd like my life back'. (Loosely translatable as ‘Get me out of this mess, somebody, I've got better things to do.')  

Next, Chairman Carl-Henric Svanberg added to the outrage by assuring the near-bankrupted fishermen and hotel owners that BP did indeed care "about the small people" – thus reminding everyone of Leona Helmsley's infamous declaration that "only little people pay taxes".  

Just how much worse could this PR operation get? 

Political revenge was predictably swift.  

President Barack Obama has a mid-term election to fight in November, and he'd already been taking a lot of personal flak from the US media for looking too distant and aloof about the Deepwater oil spill.  

So the BP duo's Laurel and Hardy act gave him just the cartoon villains he needed to make himself look really determined and decisive.  

He started with a series of personal attacks on the annoyingly fresh-faced Mr Hayward – declaring that "he wouldn't [still] be working for me after any of those statements".  

And that he wanted to know "whose ass to kick". Prime Minister David Cameron tried to weigh in with a few moderating comments to the President about not interfering in other countries' personnel issues – not that that would count for much when US investors owned 40% of the company, exactly the same as the UK.  

Moves toward a compensation plan 

So far, so personal. But then came the heavy attacks.  

First, BP found itself forced into accepting that it should pay a preliminary $20 billion into a victims' fund, without any proper judicial decision on whether liability should really rest with it or its two US-owned subcontractors – Transocean, who supplied and manned the Deepwater rig , or Halliburton, which fatally botched the cement cap on the ruptured well.  

That doesn't seem so unreasonable, on the face of it, because Louisiana needs help right now, and BP is big enough (just) to be able to bear the cost while the legal disputes continue.  

The $20 billion isn't a ring-fence, by the way – just a down-payment.  

The second attack is on rather dodgier ground.  

US Interior Secretary Ken Salazar has been threatening that BP will be forced to carry some of the costs for every US oil operation that gets cancelled because of the President's own decision to suspend of all deep-water drilling, initially for six months, in the aftermath of Deepwater. 

That's a tough line, with potentially unlimited financial implications for the company. 

The good news is that the presidential decision was effectively overturned last week by the appeals court, which ruled that Obama's ban was too loosely phrased. 

The bad news is that it's back now in a more tightly-worded format – and it'll apply up to (but not beyond)  30 November. That, at least, seems to be reining in BP's financial liabilities a little bit.  

Predictable share price chaos 

Either way, the financial threats to BP – both real and perceived – have been enough to plunge the company's shares into crisis.  

By the time of President Obama's pretty overt attacks on Mr Hayward, the ongoing crisis had pretty well halved BP's share price, from 655p to 345p – the lowest level since 1997. In round figures, the market capitalisation had been reduced by £60 billion from £127 billion to £67 billion. 

It had dropped by another 12% by the time it hit its 304p nadir – and has since bounced back by the aforementioned 33%.

Which leaves the company's market capitalisation at £75 billion – £52 billion down. 

Fitch, meanwhile, has chopped BP's credit rating from A to BBB, which is only a notch above junk.   

But whoah, surely that's overdone?  

If you believe that the whole of this mess, including the loss of future goodwill, is likely to cost £52 billion, then BP is trading at fair value. But if you don't think it'll cost as much as that – and if you don't mind the loss of this year's planned dividend – you're surely looking at a unique bargain? 

You are, of course, gambling on the unquantifiable cost of BP's threatened liability for the entire US drilling moratorium. 

And for all those crab fishermen and hoteliers whose livelihoods have been wrecked. And a hundred class-action lawsuits that claim BP misled its investors over safety at deepwater.

Against that, BP says its liabilities can save it $10 billion in tax over the next four years. You have to be happy taking a gamble when the uncertainties are this large.  

But, for those investors of a hard-headed persuasion – and they don't come much harder th
an oil investors – it does look like a unique buying opportunity. 

A 37% discount to last spring's share price takes a bit of beating. 

We tipped this share in June at 315p. We haven't been wrong yet…

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