BP has the real smell of death

THE GLOBE AND MAIL

For BP, now come the lawyers

A smeared reputation may be just the start of BP’s problems, Eric Reguly writes. Next up: A U.S. court system eager to make it pay for the worst oil spill in the nation’s history

Eric Reguly: From Saturday’s Globe and Mail

BP PLC (BP-N37.16-2.11-5.37%)is public enemy No. 1 in the United States.

Anti-BP demonstrations are flaring up across the country. The starburst green and yellow BP logos, which once stood for “Beyond Petroleum,” are being defaced at BP gas stations. A Facebook page advocating a BP boycott had more than 360,000 supporters by Friday, the same day that U.S. consumer advocacy group Public Citizen led a mass rally against the British company and its hapless CEO, Tony Hayward. The New York Daily News called him “the most hated – and clueless – man in America.”

While the protests and boycotts have smeared BP’s reputation across the globe, they are nothing compared to the price it might have to pay for the biggest oil spill in U.S. history: The potential destruction of Britain’s mightiest company.

BP’s London-listed shares went into freefall early in the week, when increasingly desperate efforts to stop the subsea blowout failed and the U.S. Justice Department launched a criminal investigation into the spill. Since flames melted the Deepwater Horizon drilling rig on April 20, sending it to the bottom of the Gulf of Mexico with 11 of its crew, BP has lost a third of its value, equivalent to more than $60-billion (U.S.). That’s almost as much as the value of Royal Bank of Canada, the world’s 10th-largest bank.

In a conference call with analysts Friday, Mr. Hayward and BP chairman Carl-Henric Svanberg rejected suggestions by U.S. senators that BP cut its nearly $3-billion quarterly dividend until the oil spill is contained. Mr. Hayward and Mr. Svanberg insisted BP has the financial capability to both shoulder the cleanup costs and continue the dividend, at least for now.

BP managed to secure a cap on the Macondo well Thursday night and is siphoning off some oil, although it will take 48 hours to assess the success of the cap-and-siphon approach.

As the broken well fouls ever larger swaths of the Gulf, and lawsuits spread faster than the oil slick, analysts, investors and lawyers are placing their bets on BP’s ability to survive intact.

A few weeks ago, when BP was relatively confident it could stem the flow, there was little sense that BP faced anything more than a very expensive cleanup bill. While some still think that’s the case, others say the company’s breakup, takeover by a rival energy heavyweight, or bankruptcy in whole or in part is probable, if not certain. “BP could be facing the death penalty in the U.S.,” said energy analyst John Kilduff, of New York hedge fund Round Earth Capital. “The viability of the company is definitely in question.”

Another high-profile analyst agrees. Dougie Youngson of London’s Arbuthnot Securities said investors who think BP’s selloff is overdone could be gravely mistaken. The company has “the real smell of death,” he said a few days ago.

The U.S. court system

The optimists note that the infamous Exxon Valdez oil spill in 1989, which dumped more than 40 million litres of crude into Alaska’s pristine Prince William Sound, ultimately did little financial damage to Exxon. The company paid about $2-billion cleaning up the spill and about $1-billion to settle criminal and civil charges. The hassle factor – Exxon spent almost two decades in litigation – seemed the biggest problem. Today, Exxon is the world’s largest oil company, by stock market value, and is considered a model operator.

The pessimists argue that BP’s size, wealth, lobbying and legal power may do little to protect it. They note that no company can control the vicissitudes of the U.S. federal and state courts, where perfectly healthy companies can get eaten alive. Big oil companies are no exception, even though they, like car makers and defence contractors, generally enjoy the red carpet treatment in Washington’s power corridors.

The Texaco case must haunt BP. In 1984, Pennzoil made a takeover offer for rival Getty Oil, which Getty accepted. A jealous Texaco induced Getty to breach its contract with Pennzoil. Pennzoil in turn unleashed the lawyers, who submitted a damage estimate of $3-billion-plus in a Texas state court. The jury clobbered Texaco with triple punitive damages, forcing the company into Chapter 11 bankruptcy protection in 1987 (Texaco is now part of Chevron).

In recent years, two other big companies didn’t make it through the courts alive. One was Arthur Andersen, Enron’s auditor, which was convicted of an obstruction of justice felony in 2002 and promptly vanished from the accounting map. The other was Canadian funeral services giant Loewen Group. It got cremated by compensatory and punitive damages in a Mississippi court, related to an insignificant takeover gone bad, and filed for bankruptcy in 1999.

Many of the analysts and energy experts who are following the BP disaster doubt BP can get off as easily as Exxon did. The Gulf of Mexico is not Prince William Sound, they note. It is one of America’s industrial, tourism and ecological heartlands, not a remote wilderness. The livelihoods of millions of workers, from hotel owners to fishermen, could be destroyed by the slick. The cleanup could take years, even decades. The costs will be enormous.

Seemingly everyone who depends on clean Gulf waters for a living has “lawyered up,” as they say on the TV crime shows. A New York lawyer, who did not want to be identified, said he “and everyone else I know is involved” with clients who intend to press claims against the British company.

“BP will face decades of litigation and it will take the company decades to recover,” said Robert Bryce, a senior fellow at the Manhattan Institute and author of Power Hungry, a book about the myths of green energy. “BP’s blowout is the trial lawyers’ Full Employment Act.”

The cost

How much could the cleanup, the litigation and the legal settlements cost? It’s impossible to say, because who or what is at fault for the ruptured Macondo well has yet to be determined. While BP is taking overall responsibility for the mess, because it was BP’s oil, at least three other big companies were involved: Transocean Inc., the rig operator; Cameron, the maker of the blowout preventer; and Halliburton Co., the well cementer.

The Dutch bank ING estimated that the compensation and cleanup – BP has already spent more than $1-billion on spill-related costs – will come to a mere $5.3-billion, or less than a 10th of the decline in BP’s value since April 20. But the ING estimate assumes the new effort to fit a cap on the well works. Credit Suisse estimates the cost at $37-billion.

The true figure could be much higher if the rogue well continues to spew oil for months. Mr. Kilduff, the energy analyst, notes that the U.S. Clean Water Act alone imposes a minimum fine of $1,000 a barrel of oil spilled. Depending on the length of the spill, these fines alone could cost billions of dollars. If the Justice Department finds criminal behaviour, the class-action lawyers, equipped with their contingency fees, could have a field day.

Some lawyers and oil executives think BP will simply be able to tough it out in the court, dragging out the day of reckoning while generating vast amounts of cash and profits from its global operations.

BP is Britain’s biggest company and the world’s leading oil producer, measured by volume. In the first quarter, it generated $7.7-billion of cash from its operations. After capital investments of $3.8-billion, it was left with $3.9-billion of free cash flow. “The legal battle will be long and slow,” said Jim Buckee, the former CEO of Talisman Energy Inc., which began life as BP Canada. “They generate buckets of cash and will be able to stall [and] dispute for a long time.”

A lawyer who used to represent BP Canada, who did not want to be identified, agrees with Mr. Buckee’s analysis. “Even assuming the flow stops today, it will take at least a year to determine the extent of the damage and to quantify the loss,” he said. “Then it will take at leas six months of motions to define what the litigation is, who is in what class action. I would suggest the basic, underlying negligence action – who screwed up and how – will take a least a year. The cases that turn on negligence will have to prove causation. They could take forever. Think cigarettes and asbestos.”

But since the liabilities related to the spill are unknown, because the oil is still spilling and because the U.S. courts are unpredictable, BP could suffer severe damage. A criminal prosecution would only heap on the pressure. The admission by Mr. Hayward, BP’s boss, to the Financial Times on Wednesday that the company was not prepared for the spill might encourage the lawyers. “What is undoubtedly true is that we did not have the tools you would want in your toolkit,” he said.

BP is already getting swamped with takeover and restructuring talk as its market value falls and the potential liability costs climb. Mr. Kilduff said that, “at the very least, BP gets broken up,” with a possible Chapter 11 bankruptcy protection filing for its U.S. operations. Robert Reich, U.S. labour secretary under president Bill Clinton, has suggested that the administration should take BP’s U.S. business into receivership until the spill has been dealt with.

Some analysts and institutional investors think asset sales are likely, with BP’s Prudhoe Bay operations on Alaska’s north slope a potential candidate. The Chinese would be eager bidders, as would BP’s competitors.

Takeover talk centres on Royal Dutch Shell, partly because it now has a higher market value than BP and partly because Mr. Hayward’s predecessor, John Browne, who was CEO until 2007, revealed in his memoirs that he tried to merge BP with Shell in 2004.

A takeover seems unlikely unless a credible estimate of the spill’s liabilities is determined. In the meantime, BP is going through hell. U.S. Interior Secretary Ken Salazar said BP’s “life is very much on the line here.”

If that was true a month ago, when he made the comment, it’s doubly true today.

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