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Seven reasons investors sweat math in BP oil spill

In response to the BP oil spill, House Speaker Pelosi called on Friday for lifting a cap on economic damages that firms can face after an oil spill.

By Staff writer / June 11, 2010

BP CEO Tony Hayward is seen at the BP Command Center in Houston on May 26, five weeks after the Deepwater Horizon exploded and sank. The company is expected to weather the disaster, but there are many unknowns.

BP/Reuters

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In roughly two months since the oil rig explosion in the Gulf of Mexico, BP has seen its share price plummet, fall steadily for several weeks, undergo a sharp one-day plunge, and then face still more declines.

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Could BP be headed into bankruptcy? Is its corporate survival at stake?

Although investment analysts predict the company will be able to cope with oil spill liabilities, the short answer right now is that uncertainty reigns.

The latest trouble spots include an increased estimate of the amount of oil spilling, pressure on the firm from President Obama to suspend its dividend to shareholders, and a call by House Speaker Nancy Pelosi (D) of California to remove a legal limit on BP's liability for economic damages related to the spill.

"The company's financial strength will allow it to survive," Argus Research analyst Philip Weiss predicted in a report this week. But "we see too many uncertainties to warrant a short-term investment in BP."

That pretty much sums up the mood on the street, as investors eye a company in crisis. Mr. Weiss figures the spill will end up being "meaningfully less" than the the amount by which the firm's market value has fallen since the April 20 explosion. He just doesn't feel it's prudent to tell people to buy the stock.

Consider that as of early June, BP's out-of-pocket costs for the spill so far totaled $1 billion. One recent Wall Street estimate put the possible spill-related costs at $40 billion. But so far BP has lost about $80 billion in market value as a corporation. (During Friday trading, the firm's market value stood at $105 billion.)

The problem is, no one knows how all the costs will finally shake out. The unknowns include:

1. The size of the spill. So far, many cost estimates had been tallied before news Thursday that the blowout is pumping 20,000 to 40,000 barrels of oil per day into the Gulf – about twice the previous estimates. More oil means more cleanup costs – but also more federal fines at the rate of $1,000 per barrel spilled.

2. Stopping the leak. "The best hope for a permanent solution now appears to be the two relief wells" that BP is drilling, analysts at Credit Suisse wrote last week. But those are not expected to be completed until August. Oil industry experts expect the relief wells to succeed. But the attempted fix is "not without risk," Credit Suisse said.

3. Cleanup. How bad will the environmental damage be? We don't know yet, so analysts are at best guessing at the cleanup costs. Hurricanes, for example, could make it harder to scoop up oil before it reaches shore.

4. Economic damage. How much will BP end up paying to fishermen and others in the Gulf region whose livelihoods are affected by the spill? Speaker Pelosi called for lifting a provision in the the Oil Pollution Act of 1990 that limits a company’s liability to $75 million for the economic damages from an oil spill, unless the company is shown to be negligent. “With or without the negligence, I don’t think there should be a cap,” she said, according to Congressional Quarterly. BP is already paying money to affected businesses (and agreed this week to speed up such payments). But changes to the 1990 act could add to BP's financial exposure.

5. A criminal probe. BP's sharpest one-day stock drop came as news emerged that the government will consider whether criminal charges should be filed against BP or any of its employees in connection with the spill. BP may not end up facing such charges, but a criminal case could have important ramifications. One example: It could end up changing the equation by which BP's smaller partners on the oil rig – Anadarko and Mitsui – may share in the cleanup costs.

6. Other legal or political fallout. A couple of examples illustrate the open-ended possibilities. Alabama's state school superintendent says he plans to bill BP for the loss of state education tax revenues related to the spill, and will sue if the company doesn't pay. And Rep. George Miller (D) of California called on BP to evaluate cleanup workers’ exposure to hazardous chemicals.

7. Future business prospects. The spill appears likely to result in a changed climate for offshore drilling – which would affect BP as one of the major firms involved in such operations. Among the biggest risks, Mr. Weiss said in an interview, would be if the federal government decided it should take regulatory actions against BP in particular, limiting its business activities in realms such as refining and natural gas as well as oil.

All these risks don't mean BP is headed for bankruptcy. But they explain why many investors aren't eager to hold the shares. The firm's stock price has been roughly cut in half by the oil spill so far, although it edged upward on Thursday and Friday.

"The uncertainties are huge," says Robert Bryce, a Manhattan Institute energy expert and author of the book, "Power Hungry."

But he adds that BP's financial resources to deal with the costs and litigation ahead are also huge. "Yes, the total bill could cost $40 billion," he says. "But that's not a bill that they pay all at once."

The company is generating lots of cash from its other energy businesses around the world, and can sell assets if needed. So, while some investment analysts say a rising bill makes bankruptcy a possibility, Bryce calls that unlikely.

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